Financial Regulation in a Quantitative Model of the Modern Banking System
76 Pages Posted: 17 Mar 2016 Last revised: 12 Nov 2018
Date Written: September 24, 2018
How does the shadow banking system respond to changes in capital regulation of commercial banks? We propose a tractable quantitative general equilibrium model with regulated and unregulated banks to study the unintended consequences of capital requirements. Tightening the capital requirement from the status quo leads to a safer banking system despite riskier shadow banking activity. A reduction in aggregate liquidity provision decreases the funding costs of all banks, raising profits and investment. Calibrating the model to data on financial institutions in the U.S., the optimal capital requirement is around 17%.
Keywords: Shadow Banks, Liquidity Demand, Capital Requirement, Bank Regulation
JEL Classification: E44, G21, G28
Suggested Citation: Suggested Citation