Discussion Paper Details

Please find the details for DP9008 in an easy to copy and paste format below:

Full Details   |   Bibliographic Reference

Full Details

Title: Cyclical Adjustment of Capital Requirements: A Simple Framework

Author(s): Rafael Repullo

Publication Date: June 2012

Keyword(s): Banking regulation, Basel II, Capital requirements and Procyclicality

Programme Area(s): Financial Economics

Abstract: We present a simple model of an economy with heterogeneous banks that may be funded with uninsured deposits and equity capital. Capital serves to ameliorate a moral hazard problem in the choice of risk. There is a fixed aggregate supply of bank capital, so the cost of capital is endogenous. A regulator sets risk-sensitive capital requirements in order to maximize a social welfare function that incorporates a social cost of bank failure. We consider the effect of a negative shock to the supply of bank capital and show that optimal capital requirements should be lowered. Failure to do so would keep banks safer but produce a large reduction in aggregate investment. The result provides a rationale for the cyclical adjustment of risk-sensitive capital requirements.

For full details and related downloads, please visit:

Bibliographic Reference

Repullo, R. 2012. 'Cyclical Adjustment of Capital Requirements: A Simple Framework'. London, Centre for Economic Policy Research.