Bond Finance, Bank Finance, and Bank Regulation

Abstract

In this paper, I build a continuous-time macro-finance model in which firms can access both bond credit and bank credit. The model captures the simple idea that the presence of bond financing lowers the price elasticity of demand for bank loans. I find that the optimal capital adequacy ratio is quantitatively sensitive to the presence of bond financing and that models would overstate the banking sector's recovery rate if they omit bond financing. Furthermore, the model highlights that an economy's optimal capital requirement highly depends on the efficiency of its bankruptcy procedure and the risk profile of its real sector.

Keywords: bank credit, bond credit, capital requirement, and macro-prudential regulation

JEL Classification: G21, G28, E44