Capital Requirements in a Quantitative Model of Banking Industry Dynamics

68 Pages Posted: 7 Jan 2019

See all articles by Dean Corbae

Dean Corbae

University of Wisconsin - Madison

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia; University of Maryland - College Park

Multiple version iconThere are 2 versions of this paper

Date Written: January 2019

Abstract

We develop a model of banking industry dynamics to study the quantitative impact of capital requirements on equilibrium bank risk taking, commercial bank failure, interest rates on loans, and market structure. We propose a market structure where big banks with market power interact with small, competitive fringe banks. Banks face idiosyncratic funding shocks in addition to aggregate shocks to the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks' buffer stock of net worth. We show the model predictions are consistent with untargeted business cycle properties, the bank lending channel, and empirical studies of the role of concentration on financial stability. We then conduct a series of counterfactuals (including countercyclical and size contingent (e.g. SIFI) capital requirements). We find that regulatory policies can have an important impact on market structure in the banking industry which, along with selection effects, can generate changes in allocative efficiency.

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Suggested Citation

Corbae, Dean and D'Erasmo, Pablo, Capital Requirements in a Quantitative Model of Banking Industry Dynamics (January 2019). NBER Working Paper No. w25424. Available at SSRN: https://ssrn.com/abstract=3311398

Dean Corbae (Contact Author)

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

University of Maryland - College Park ( email )

College Park, MD 20742
United States

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