Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/171550 
Year of Publication: 
2009
Series/Report no.: 
Economics Working Paper Series No. 09/107
Publisher: 
ETH Zurich, CER-ETH - Center of Economic Research, Zurich
Abstract: 
In this paper, we argue for a regulatory framework under which a bank’s required level of equity capital depends on the equity capital of its peers. Such bankingon- the-average rules are transparent and could also be combined with the current regulatory framework. In addition, we argue that banking-on-the-average rules ensure the build-up of bank equity capitals in booms and thus avoid excessive leverage. Prudent banks can impose prudency on other banks. In a simple model of a banking system, we show that a banking-on-the-average framework can deliver the socially optimal solution because it induces banks to abstain from gambling. Moreover, it alleviates socially harmful consequences of conventional equity-capital rules, which may induce banks to excessively cut back on lending or liquidate desirable long-term investment projects in downturns.
Subjects: 
banking on the average
equity-capital requirements
banking system
banking crisis
JEL: 
G21
G28
Document Type: 
Working Paper

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