Capital requirements, risk choice, and liquidity provision in a business-cycle model

Abstract

This paper develops a quantitative dynamic general equilibrium model in which households' preferences for safe and liquid assets constitute a violation of Modigliani and Miller. I show that the scarcity of these coveted assets created by increased bank capital requirements can reduce overall bank funding costs and increase bank lending. I quantify this mechanism in a two-sector business cycle model featuring a banking sector that provides liquidity and has excessive risk-taking incentives. Under reasonable parametrizations, the marginal benet of higher capital requirements related to this channel signicantly exceeds the marginal cost, indicating that US capital requirements have been sub-optimally low.

Macroprudential Regulation of Investment Funds

“…At this point it is important to put this channel into perspective. First, a key role for available liquidity in welfare analysis is also found in the analysis of bank regulation in Begenau (2020) and Begenau and Landvoigt (2021). Second, while in our model households suffer a direct welfare loss, this can in principle work via different agents that have a demand for safe and liquid assets.…”

“…Likewise, we set n = 1/3 in the steady state and choose the utility weight of labour ψ n accordingly. Utility from deposits is also logarithmic, σ m = 1, and the steady state utility weight δ d is set to the standard value of 0.02 (see, e.g., Begenau, 2020). The labour share is set to α n = 0.67, in accordance with European data.…”

Bank Market Power and Monetary Policy Transmission: Evidence from a Structural Estimation

“…While this work usually features a static industry equilibrium, we introduce the dynamic adjustment of banks' balance sheets to study the role of maturity transformation and financial frictions. Our paper is also tangentially related to recent work that uses dynamic banking models to study optimal capital regulation (Begenau (2018), Begenau and Landvoigt (2021), Landvoigt, Van Nieuwerburgh, and Elenev (2021)). In particular, Corbae and D'Erasmo (2021) develop a dynamic dominant-fringe model to study the quantitative impact of regulatory policies on bank risk-taking and market structure.…”

The Anatomy of the Transmission of Macroprudential Policies

“…5 Our paper is also related to the empirical literature on macroprudential policies (Aiyar, Calomiris, and Wieladek (2014), Jimenez et al (2017), Ayyagari, Beck, and Martinez Peria (2019), Gropp et al (2019), Benetton (2021), Benetton et al (2021), De Marco, Kneer, and Wieladek (2021)). 6 The theoretical literature on macroprudential policies (Landvoigt and Begenau (2022), Elenev, Landvoigt, and van Nieuwerburgh (2021), Begenau (2020), Kashyap, Tsomocos, and Vardoulakis (2020), Malherbe and Bahaj (2020)) has mainly focused on policies (mostly capital requirements) aimed at limiting bank risk-taking. 7 Auer, Matyunina, and Ongena (2022) and Basten (2020) show that capital buffers on Swiss residential lending led to higher growth in commercial lending and shifted mortgages from less to more resilient banks, respectively.…”