Bank Capital Regulation in a Zero Interest Environment
59 Pages Posted: 22 Feb 2018 Last revised: 14 Jan 2019
Date Written: January 12, 2019
How do near-zero deposit rates affect (optimal) bank capital regulation and risk taking? I study these questions in a tractable, dynamic equilibrium model, in which forward-looking banks compete imperfectly for deposit funding, subject to a (zero) lower bound constraint on deposit rates (ZLB). At the ZLB, capital requirements become less effective in curbing excessive risk-taking incentives, as they disproportionately hurt franchise values. As a consequence, optimal dynamic capital requirements vary with the level of interest rates if the ZLB binds occasionally. Subsidizing bank funding costs at the ZLB dampens risk-taking, but may reduce overall welfare.
Keywords: Zero lower bound, search for yield, capital regulation, bank competition, risk shifting, franchise value
JEL Classification: G21, G28, E43
Suggested Citation: Suggested Citation