Financial Regulation in a Quantitative Model of the Modern Banking System
61 Pages Posted: 17 Mar 2016 Last revised: 20 Apr 2017
Date Written: April 19, 2017
How does the shadow banking system respond to changes in the capital regulation of commercial banks? We propose a tractable, quantitative general equilibrium model with regulated and unregulated banks to study the unintended consequences of regulatory policy. Tightening the capital requirement from the status quo creates a safer banking system despite more shadow banking activity. A reduction in aggregate liquidity provision decreases the funding costs of all banks, raising profits and reducing risk-taking incentives. Calibrating the model to data on financial institutions in the U.S., we find the optimal capital requirement is around 15%.
Keywords: Shadow Banks, Liquidity Demand, Capital Requirement, Bank Regulation
JEL Classification: E44, G21, G28
Suggested Citation: Suggested Citation