Capital Regulation and Bank Failure Contagion

48 Pages Posted: 23 Apr 2020 Last revised: 25 Sep 2020

See all articles by Daniel McKeever

Daniel McKeever

SUNY at Binghamton - School of Management

Date Written: March 27, 2020

Abstract

I provide simulation evidence that the complex systems framework is well-suited for explaining
the historical distribution of U.S. commercial bank failure cascades. I use the complex systems
framework to test a model of the efficacy of microprudential (bank-level) ratio-based capital
adequacy regulations. I find that these requirements generally have the adverse effect of
increasing the likelihood of large failure cascades. This adverse effect is especially pronounced
under simulation conditions that mimic economic downturns. If banks use more leverage in
response to decreased capital adequacy requirements, the likelihood of failure cascades increases
only minimally. These results suggest that existing microprudential capital adequacy
requirements might be counterproductive to the goal of mitigating bank failure cascades, and
provide theoretical support for a countercyclical capital buffer.

Keywords: Bank Failures, Complex Systems, Systemic Risk, Capital Requirements, Network Structure, Regulatory Policy

JEL Classification: C15, G01, G21, G28

Suggested Citation

McKeever, Daniel, Capital Regulation and Bank Failure Contagion (March 27, 2020). Available at SSRN: https://ssrn.com/abstract=3564267 or http://dx.doi.org/10.2139/ssrn.3564267

Daniel McKeever (Contact Author)

SUNY at Binghamton - School of Management ( email )

P.O. Box 6015
Binghamton, NY 13902-6015
United States

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