Dynamic Bank Capital Regulation in the Presence of Shadow Banks

83 Pages Posted: 21 Jan 2021 Last revised: 13 Dec 2022

See all articles by Arsenii Mishin

Arsenii Mishin

National Research University Higher School of Economics - Faculty of Economics; National Research University Higher School of Economics - Faculty of Economics

Date Written: December 13, 2022

Abstract

Regulated banks expand relative to shadow banks in recessions and when credit spreads are high, while regulated banks shrink relative to shadow banks in expansions and when credit spreads are low. Motivated by these facts, I build a quantitative general equilibrium model with endogenous risk taking to study how competitive interactions between regulated banks and shadow banks affect optimal dynamic capital requirements. Limited liability and deposit insurance can lead regulated banks to provide socially inefficient risky loans when the returns on safer loans decline. Competition for scarcer funding can further lower the net returns on safe loans, making it more attractive for regulated banks to exploit the shield of limited liability with risky loans. Higher capital requirements can reduce inefficient risk at the cost of lower liquidity provision and some migration of credit from regulated banks to shadow banks. Accounting for the interactions of regulated and shadow banks can change the magnitude and direction of the optimal response of capital requirements to shocks that drive the business cycle. Moreover, Basel-III style rules that differentiate between the type of bank loans are much better at mimicking the Ramsey optimal capital requirements than standard rules that aggregate loans. The performance of such dynamic rules can be further improved once they are combined with a small static capital buffer.

Keywords: Shadow Banks; Capital Requirements; Basel III; Liquidity Provision; Risk Taking

JEL Classification: E44, E58, G21, G23, G28, C54

Suggested Citation

Mishin, Arsenii, Dynamic Bank Capital Regulation in the Presence of Shadow Banks (December 13, 2022). Available at SSRN: https://ssrn.com/abstract=3731418 or http://dx.doi.org/10.2139/ssrn.3731418

Arsenii Mishin (Contact Author)

National Research University Higher School of Economics - Faculty of Economics ( email )

Shabolovka 26
Moscow, 119049
Russia

National Research University Higher School of Economics - Faculty of Economics ( email )

Shabolovka 26
Moscow, 119049
Russia

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