Macroprudential policy with capital buffers

Abstract

This paper studies optimal bank capital requirements in a model of endogenous bank funding conditions. I find that requirements should be higher during good times such that a macroprudential "buffer" is provided. However, whether banks can use buffers to maintain lending during a financial crisis depends on the capital requirement during the subsequent recovery. The reason is that a high requirement during the recovery lowers bank shareholder value during the crisis and thus creates funding-market pressure to use buffers for deleveraging rather than for maintaining lending. Therefore, buffers are useful if banks are not required to rebuild them quickly.

Assessing the Impact of Basel III: Evidence from Structural Macroeconomic Models

“…This results in occasional episodes with sharp increases in spreads and deeper downturns, helping explain observed macroeconomic asymmetries such as negatively skewed aggregate investment (Holden et al, 2019). A similar approach has been used to analyze the effectiveness of policy: pre-crisis capital requirements in the United States were found to be close to optimal in terms of the aggregate welfare of savers and borrowers where default and occasionally binding borrowing constraints in both the non-financial and financial sectors are present (Elenev et al, 2021); while capital buffers are found to be more effective in restricting bank equity payouts, rather than bank lending over financial cycles, in examining the implementation of the capital conservation buffer and the countercyclical capital buffer (Schroth, 2021). 2.2.2.…”

Macroprudential Regulation: A Risk Management Approach

“…Such models have been developed but they either tend to abstract from risk contagion between banks by modeling the financial sector as a single large bank, like in Cline (2017), or as a continuum of ex-ante homogeneous banks. Both approaches make the concept of ex-ante systemic importance difficult to implement in a practical application (Malherbe, 2020;Schroth, 2021;Mankart et al, 2020). We, therefore, offer two alternative approaches to quantifying the required macroprudential buffers: one which builds on actual practice and a novel approach more related to recent academic research on systemic risk and macroprudential policy.…”

The contribution of macroprudential policies to banks' resilience: Lessons from the systemic crises and the COVID‐19 pandemic shock

“…The first strand includes studies by Gauthier et al (2012), Berger and Bouwman (2013) and Niţoi et al (2019), among others, and focuses on the impact on individual banks' risk‐taking behavior. The second strand, involving the studies of Qureshi et al (2011), Jiménez et al (2017), and Schroth (2021) evaluates the outcome of these policies on credit and real output for the entire economy. A consensus exists in these two strands of the literature that the precrisis implementation of capital macroprudential policies leads banks to reduce their default profitability and the credit crunch, thereby helping the economy recover faster.…”