The Forced Safety Effect: How Higher Capital Requirements Can Increase Bank Lending

67 Pages Posted: 9 Mar 2020

See all articles by Saleem Bahaj

Saleem Bahaj

UCL Economics

Frederic Malherbe

University College London - Department of Economics

Date Written: February 14, 2020

Abstract

Government guarantees generate an implicit subsidy for banks. A capital requirement reduces this subsidy, through a simple liability composition effect. However, the guarantees also make a bank undervalue loans that generates surplus in the states of the world where it defaults. Raising the capital requirement makes the bank safer, which alleviates this problem. We dub this mechanism, which we argue is empirically relevant, the forced safety effect.

Suggested Citation

Bahaj, Saleem and Malherbe, Frederic, The Forced Safety Effect: How Higher Capital Requirements Can Increase Bank Lending (February 14, 2020). Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3538266

Saleem Bahaj

UCL Economics ( email )

30 Gordon Street
London, England WC1H 0AX
United Kingdom

Frederic Malherbe (Contact Author)

University College London - Department of Economics ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

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