Market-Based Bank Capital Regulation

67 Pages Posted: 3 Sep 2013

See all articles by Jeremy Bulow

Jeremy Bulow

Stanford University; National Bureau of Economic Research (NBER)

Paul Klemperer

University of Oxford - Department of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2013


Today’s regulatory rules, especially the easily-manipulated measures of regulatory capital, have led to costly bank failures.

We design a robust regulatory system such that (i) bank losses are credibly borne by the private sector (ii) systemically important institutions cannot collapse suddenly; (iii) bank investment is counter-cyclical; and (iv) regulatory actions depend upon market signals (because the simplicity and clarity of such rules prevents gaming by firms, and forbearance by regulators, as well as because of the efficiency role of prices).

One key innovation is “ERNs” (equity recourse notes - superficially similar to, but importantly distinct from, “cocos”) which gradually "bail in" equity when needed. Importantly, although our system uses market information, it does not rely on markets being “right”.

Keywords: bail-in, bank, bank capital, bank crisis, capital requirements, contingent capital, contingent convertible bond, debt overhang, deposit insurance, living wills, regulatory capital, regulatory forbearance, SIFI, systemically important financial institution, too-big-to-fail

JEL Classification: G10, G21, G28, G32

Suggested Citation

Bulow, Jeremy I. and Klemperer, Paul, Market-Based Bank Capital Regulation (August 2013). CEPR Discussion Paper No. DP9618, Available at SSRN:

Jeremy I. Bulow (Contact Author)

Stanford University ( email )

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Paul Klemperer

University of Oxford - Department of Economics ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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