Dynamic Bank Capital Regulation in Equilibrium

63 Pages Posted: 18 Oct 2017 Last revised: 16 Feb 2018

See all articles by Douglas M. Gale

Douglas M. Gale

New York University (NYU) - Department of Economics

Andrea Gamba

University of Warwick - Finance Group

Marcella Lucchetta

Ca Foscari University of Venice

Date Written: February 11, 2018

Abstract

We study optimal bank regulation in an economy with aggregate uncertainty. Bank liabilities are used as “money” and hence earn lower returns than equity. In laissez faire equilibrium, banks maximize market value, trading off the funding advantage of debt against the risk of costly default. The capital structure is not socially optimal because external costs of distress are not internalized by the banks. The constrained efficient allocation is characterized as the solution to a planner’s problem. Efficient regulation is procyclical, but countercyclical relative to laissez faire. We show that simple leverage constraints can get the decentralized economy close to the constrained efficient outcome.

Keywords: Bank Regulation, Capital Requirements, General Equilibrium, Aggregate Risk

JEL Classification: G21, E32, E58

Suggested Citation

Gale, Douglas M. and Gamba, Andrea and Lucchetta, Marcella, Dynamic Bank Capital Regulation in Equilibrium (February 11, 2018). WBS Finance Group Research Paper. Available at SSRN: https://ssrn.com/abstract=3053978 or http://dx.doi.org/10.2139/ssrn.3053978

Douglas M. Gale

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States
(212) 998-8944 (Phone)
(212) 995-3932 (Fax)

Andrea Gamba (Contact Author)

University of Warwick - Finance Group ( email )

Scarman Road
Coventry, CV4 7AL
Great Britain
+44 (0)24 765 24 542 (Phone)
+44 (0)24 765 23 779 (Fax)

Marcella Lucchetta

Ca Foscari University of Venice ( email )

Venice
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
139
rank
203,235
Abstract Views
679
PlumX Metrics