Bank Liquidity and Capital Regulation in General Equilibrium

39 Pages Posted: 8 Nov 2014  

Francisco Covas

Board of Governors of the Federal Reserve System

John C. Driscoll

Federal Reserve Board

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

Federal Reserve Board ( email )

20th and C Streets, NW
Washington, DC 20551
United States

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

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