Optimal Bank Capitalization in Crowded Markets

52 Pages Posted: 2 Oct 2015 Last revised: 11 Dec 2017

See all articles by Christoph Bertsch

Christoph Bertsch

Sveriges Riksbank - Research Division

Mike Mariathasan

KU Leuven- Faculty of Economics & Business

Multiple version iconThere are 2 versions of this paper

Date Written: December 11, 2017

Abstract

We study banks’ optimal equity buffer in general equilibrium and their response to under-capitalization. Making progress towards a “pecking order theory” for private recapitalizations, our benchmark model identifies equity issuance as individually and socially optimal, compared to deleveraging, as well as conditions that invert the individually optimal ranking. Imperfectly elastic supply of capital, incomplete insurance markets and costly bankruptcies give rise to inefficiently high leverage ex-ante, and to excessive capital shortfalls and insolvencies ex-post. Abstracting from moral hazard and informational asymmetries, we therefore provide a novel rationale for macroprudential capital regulation and new testable implications about banks’ capital structure management.

Keywords: Bank capital, recapitalization, macroprudential regulation, incomplete markets, financial market segmentation, constrained inefficiency

JEL Classification: D5, D6, G21, G28

Suggested Citation

Bertsch, Christoph and Mariathasan, Mike, Optimal Bank Capitalization in Crowded Markets (December 11, 2017). Available at SSRN: https://ssrn.com/abstract=2667636 or http://dx.doi.org/10.2139/ssrn.2667636

Christoph Bertsch (Contact Author)

Sveriges Riksbank - Research Division ( email )

S-103 37 Stockholm
Sweden

Mike Mariathasan

KU Leuven- Faculty of Economics & Business ( email )

Naamsestraat 69
Leuven, B-3000
Belgium

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