Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/53428
Authors: 
Hart, Oliver
Zingales, Luigi
Year of Publication: 
2009
Series/Report no.: 
Nota di lavoro // Fondazione Eni Enrico Mattei: Institutions and markets 124.2009
Abstract: 
We design a new, implementable capital requirement for large financial institutions (LFIs) that are too big to fail. Our mechanism mimics the operation of margin accounts. To ensure that LFIs do not default on either their deposits or their derivative contracts, we require that they maintain an equity cushion sufficiently great that their own credit default swap price stays below a threshold level, and a cushion of long term bonds sufficiently large that, even if the equity is wiped out, the systemically relevant obligations are safe. If the CDS price goes above the threshold, the LFI regulator forces the LFI to issue equity until the CDS price moves back down. If this does not happen within a predetermined period of time, the regulator intervenes. We show that this mechanism ensures that LFIs are always solvent, while preserving some of the disciplinary effects of debt.
Subjects: 
Banks
Capital Requirement
Too Big to Fail
JEL: 
G21
G28
Document Type: 
Working Paper

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