Aggregate Bank Capital and Credit Dynamics

53 Pages Posted: 30 Jun 2016  

Nataliya Klimenko

University of Zurich

Sebastian Pfeil

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE); Erasmus Research Institute of Management (ERIM)

Jean-Charles Rochet

GFRI, University of Geneva; Swiss Finance Institute; University of Zurich - Swiss Banking Institute (ISB)

Gianni De Nicolo

International Monetary Fund and CESifo

Date Written: June 1, 2016

Abstract

We develop a novel dynamic model of banking showing that aggregate bank capital is an important determinant of bank lending. In our model commercial banks finance their loans with deposits and equity, while facing equity issuance costs. Because of this financial friction, banks build equity buffers to absorb negative shocks. Aggregate bank capital determines the dynamics of lending. Notably, the equilibrium loan rate is a decreasing function of aggregate capitalization. The competitive equilibrium is constrained inefficient, because banks do not internalize the consequences of individual lending decisions for the future loss-absorbing capacity of the banking sector. In particular, we find that unregulated banks lend too much. Imposing a minimum capital ratio helps tame excessive lending, which enhances stability of the banking system.

Keywords: macro-model with a banking sector, aggregate bank capital, pecuniary externality, capital requirements

JEL Classification: E21, E32, F44, G21, G28

Suggested Citation

Klimenko, Nataliya and Pfeil, Sebastian and Rochet, Jean-Charles and De Nicolo, Gianni, Aggregate Bank Capital and Credit Dynamics (June 1, 2016). Swiss Finance Institute Research Paper No. 16-42. Available at SSRN: https://ssrn.com/abstract=2801995 or http://dx.doi.org/10.2139/ssrn.2801995

Nataliya Klimenko (Contact Author)

University of Zurich ( email )

Plattenstrasse 32
Zürich, CH-8006
Switzerland

Sebastian Pfeil

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Jean-Charles Rochet

GFRI, University of Geneva ( email )

102 Bd Carl-Vogt
Genève, GA CH - 1205
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

University of Zurich - Swiss Banking Institute (ISB) ( email )

Plattenstrasse 14
CH-8032 Zurich, Zurich 8032
Switzerland

Gianni De Nicolo

International Monetary Fund and CESifo ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8200 (Phone)
202-623-7271 (Fax)

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