Citation

Discussion Paper Details

Please find the details for DP8897 in an easy to copy and paste format below:

Full Details

Title: The Procyclical Effects of Bank Capital Regulation

Author(s): Rafael Repullo and Javier Suarez

Publication Date: March 2012

Keyword(s): Banking regulation, Basel capital requirements, Capital market frictions, Credit rationing, Loan defaults, Relationship banking and Social cost of bank failure

Programme Area(s): Financial Economics

Abstract: We develop and calibrate a dynamic equilibrium model of relationship lending in which banks are unable to access the equity markets every period and the business cycle is a Markov process that determines loans' probabilities of default. Banks anticipate that shocks to their earnings and the possible variation of capital requirements over the cycle can impair their future lending capacity and, as a precaution, hold capital buffers. We compare the relative performance of several capital regulation regimes, including one that maximizes a measure of social welfare. We show that Basel II is significantly more procyclical than Basel I, but makes banks safer. For this reason, it dominates Basel I in terms of welfare except for small social costs of bank failure. We also show that for high values of this cost, Basel III points in the right direction, with higher but less cyclically-varying capital requirements.

For full details and related downloads, please visit: https://cepr.org/active/publications/discussion_papers/dp.php?dpno=8897

Bibliographic Reference

Repullo, R and Suarez, J. 2012. 'The Procyclical Effects of Bank Capital Regulation'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=8897