Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model

71 Pages Posted: 11 Mar 2015 Last revised: 17 Feb 2019

See all articles by Juliane Begenau

Juliane Begenau

Stanford University - Graduate School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Date Written: January 14, 2019

Abstract

This paper develops a dynamic general equilibrium model to quantify the effects of bank capital requirements. Households' preferences for liquid assets imply a liquidity premium on deposits. The banking sector supplies deposits and has excessive risk-taking incentives. I show that the scarcity of deposits created by an increased capital requirement can reduce the cost of capital for banks and increase bank lending. A higher capital requirement also increases banks' monitoring incentives, which improves the efficiency of banks' activities. Under reasonable parametrizations, the marginal benefit of a higher capital requirement related to this channel significantly exceeds the marginal cost, indicating that U.S. capital requirements have been suboptimally low.

Keywords: Capital Requirements, Bank Regulation, Bank Lending, Demand for Safe Assets, Business Cycles

JEL Classification: E44, G21, G28

Suggested Citation

Begenau, Juliane, Capital Requirements, Risk Choice, and Liquidity Provision in a Business Cycle Model (January 14, 2019). Available at SSRN: https://ssrn.com/abstract=2576277 or http://dx.doi.org/10.2139/ssrn.2576277

Juliane Begenau (Contact Author)

Stanford University - Graduate School of Business ( email )

Stanford, CA 94305
United States
6507245661 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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