Bank Liquidity and Capital Regulation in General Equilibrium

39 Pages Posted: 8 Nov 2014

See all articles by Francisco Covas

Francisco Covas

Board of Governors of the Federal Reserve System

John C. Driscoll

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: September 12, 2014

Abstract

We develop a nonlinear dynamic general equilibrium model with a banking sector and use it to study the macroeconomic impact of introducing a minimum liquidity standard for banks on top of existing capital adequacy requirements. The model generates a distribution of bank sizes arising from differences in banks' ability to generate revenue from loans and from occasionally binding capital and liquidity constraints. Under our baseline calibration, imposing a liquidity requirement would lead to a steady-state decrease of about 3 percent in the amount of loans made, an increase in banks' holdings of securities of at least 6 percent, a fall in the interest rate on securities of a few basis points, and a decline in output of about 0.3 percent. Our results are sensitive to the supply of safe assets: the larger the supply of such securities, the smaller the macroeconomic impact of introducing a minimum liquidity standard for banks, all else being equal. Finally, we show that relaxing the liquidity requirement under a situation of financial stress dampens the response of output to aggregate shocks.

Keywords: Liquidity requirements, capital requirements, macroprudential policy, incomplete markets

JEL Classification: D52, E13, G21, G28

Suggested Citation

Covas, Francisco and Driscoll, John C., Bank Liquidity and Capital Regulation in General Equilibrium (September 12, 2014). FEDS Working Paper No. 2014-85, Available at SSRN: https://ssrn.com/abstract=2520193 or http://dx.doi.org/10.2139/ssrn.2520193

Francisco Covas (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

John C. Driscoll

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/john-c-driscoll.htm

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