Capital Regulation and Credit Fluctuations

39 Pages Posted: 28 Sep 2012

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Jean-Charles Rochet

GFRI, University of Geneva; Swiss Finance Institute; University of Zurich - Swiss Banking Institute (ISB)

Date Written: August 2012

Abstract

We provide a rationale for imposing counter-cyclical capital ratios on banks. In our simple model, bankers cannot pledge the entire future revenues to investors, which limits borrowing in good and bad times. Complete markets do not sufficiently stabilize credit fluctuations, as banks allocate too much borrowing capacity to good states and too little to bad states. As a consequence, bank credit, output, capital prices or wages are excessively volatile. Imposing a (stricter) capital ratio in good states corrects the misallocation of the borrowing capacity, increases expected output and can be beneficial to all agents in the economy. Although in our economy, all agents are risk-neutral, counter-cyclical capital ratios are an effective stabilization tool. To ensure this effectiveness, capital ratios have to be based on ex ante equity capital, as classical capital ratios can be bypassed.

Keywords: Complete Markets, Credit Fluctuations, Macroprudential Regulation, Misallocation of Borrowing Capacity

JEL Classification: D86, G21, G28

Suggested Citation

Gersbach, Hans and Rochet, Jean-Charles, Capital Regulation and Credit Fluctuations (August 2012). CEPR Discussion Paper No. DP9077. Available at SSRN: https://ssrn.com/abstract=2153527

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Jean-Charles Rochet

GFRI, University of Geneva ( email )

102 Bd Carl-Vogt
Genève, CH - 1205
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

University of Zurich - Swiss Banking Institute (ISB) ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland

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