Optimal Dynamic Capital Requirements
31 Pages Posted: 14 Nov 2017
Date Written: September 2017
We characterize welfare maximizing capital requirement policies in a quantitative macro-banking model with household, firm and bank defaults calibrated to Euro Area data. We optimize on the level of the capital requirements applied to each loan class and their sensitivity to changes in default risk. We find that getting the level right (so that bank failure risk remains contained) is of foremost importance, while the optimal sensitivity to default risk is positive but typically smaller than under Basel IRB formulas. Starting from low levels, savers and borrowers benefit from higher capital requirements. At higher levels, only savers prefer tighter requirements.
Keywords: Macroprudential policy; Bank fragility; Capital requirements; Financial frictions; Default risk
JEL Classification: E3, E44, G01, G21
Suggested Citation: Suggested Citation