Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/229029 
Year of Publication: 
2020
Series/Report no.: 
ECB Working Paper No. 2415
Publisher: 
European Central Bank (ECB), Frankfurt a. M.
Abstract: 
I analyze the impact of raising capital requirements on the quantity, composition, and riskiness of aggregate investment in a model in which firms borrow from both bank and non-bank lenders. The bank funds loans with insured deposits and costly equity, monitors borrowers, and must maintain a minimum capital to asset ratio. Non-banks have deep pockets and competitively price loans. A tight capital requirement on the bank reduces risk-shifting and decreases bank leverage, reducing the risk of costly bank failure. In response, though, the bank can change both price and non-price contract terms. This may induce firms to substitute out of bank finance, leading to a theoretically ambiguous effect on the profile of aggregate investment. Quantitatively, I find that the bank's incentive to insure itself against issuing costly equity and competition from the non-bank sector mutes the long run impact of raising capital requirements. Increasing the capital requirement from 8% to 26% eliminates bank failures with effectively no change in the quantity or riskiness of aggregate investment.
Subjects: 
banking
capital requirements
business cycles
JEL: 
G2
E5
E6
E32
E44
Persistent Identifier of the first edition: 
ISBN: 
978-92-899-4058-0
Document Type: 
Working Paper

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