The Effects of Capital Requirements on Good and Bad Risk-Taking

61 Pages Posted: 5 Nov 2020

See all articles by N. Aaron Pancost

N. Aaron Pancost

University of Texas at Austin McCombs School of Business

Roberto Robatto

University of Wisconsin - Madison

Date Written: December 1, 2019

Abstract

We study optimal capital requirement regulation in a dynamic quantitative model in which nonfinancial firms, as well as households, hold deposits. Firms hold deposits for precautionary reasons and to facilitate the acquisition of production inputs. Our theoretical analysis identifies a novel general equilibrium channel that operates through firms’ deposits and mitigates the cost of increasing capital requirements. We calibrate our model and find that the optimal capital requirement is 18.7% but only 13.6% in a comparable model in which only households hold deposits. Our novel channel accounts for most of the difference.

Keywords: capital requirements, deposit insurance, idiosyncratic risk, safe assets

JEL Classification: E21, G21, G32

Suggested Citation

Pancost, N. Aaron and Robatto, Roberto, The Effects of Capital Requirements on Good and Bad Risk-Taking (December 1, 2019). ESRB: Working Paper Series No. 2019/104, Available at SSRN: https://ssrn.com/abstract=3723440 or http://dx.doi.org/10.2139/ssrn.3723440

N. Aaron Pancost (Contact Author)

University of Texas at Austin McCombs School of Business ( email )

Red McCombs School of Business
Austin, TX 78712
United States

Roberto Robatto

University of Wisconsin - Madison ( email )

975 University Avenue
Madison, WI 53706
United States

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