Should Bank Capital Requirements Be Less Risk-Sensitive Because of Credit Constraints?

57 Pages Posted: 16 May 2017 Last revised: 2 May 2018

See all articles by Gene Ambrocio

Gene Ambrocio

Bank of Finland

Esa Jokivuolle

Bank of Finland, Research Unit

Date Written: May 15, 2017

Abstract

We consider optimal capital requirements for banks' lending activities when the potential trade-off between financial stability and economic (productivity) growth is taken into account. Both sides of the trade-off are affected by banks' credit allocation, which in turn is affected by the risk weights used to set capital requirements on bank loans. We find that when firms are credit constrained, the optimal risk weights are flatter than those that are only set to safeguard against bank failures and their social costs. This provides an additional rationale for capital requirements to be less 'risk-sensitive'. Differences in company productivity have a further effect on the profile of optimal risk weights, and may amplify the ‘flattening’ effect.

Keywords: bank regulation, capital requirements, risk weights, credit constraints, productivity

JEL Classification: E44, G21, G28

Suggested Citation

Ambrocio, Gene and Jokivuolle, Esa, Should Bank Capital Requirements Be Less Risk-Sensitive Because of Credit Constraints? (May 15, 2017). Bank of Finland Research Discussion Paper No. 10/2017, Available at SSRN: https://ssrn.com/abstract=2968867

Gene Ambrocio (Contact Author)

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

Esa Jokivuolle

Bank of Finland, Research Unit ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland
+358 10 831 2309 (Phone)

HOME PAGE: http://www.bof.fi/en/suomen_pankki/organisaatio/asiantuntijoita/jokivuolle_esa/

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