Implications of Bank Regulation for Loan Supply and Bank Stability: A Dynamic Perspective
European Journal of Finance 2019, 25(16), 1527-1550. DOI:10.1080/1351847X.2019.1614084
Posted: 5 Aug 2019 Last revised: 26 Jan 2020
Date Written: May 9, 2019
We show that internal funds play a particular role in the regulation of bank capital, which has not received much attention, yet. A bank's decision on loan supply and capital structure determines its immediate bankruptcy risk as well as the future availability of internal funds. These internal funds in turn determine a bank's future costs of external finance and its future vulnerability to bankruptcy risks. Using a partial equilibrium model, we study how internal funds affect these intra- and intertemporal links. Moreover, our positive analysis identifies the effects of risk-weighted capital-to-asset ratios, liquidity coverage ratios and regulatory margin calls on the dynamics of internal funds and thus loan supply and bank stability. Only regulatory margin calls or large liquidity coverage ratios achieve bank stability for all risk levels, but for large risks a bank will stop credit intermediation.
Keywords: bank lending, banking crisis, bank capital regulation, liquidity regulation
JEL Classification: G01, G21, G28, E32
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