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Capital Adequacy and Liquidity in Banking Dynamics: Theory and Regulatory Implications

Author

Listed:
  • Cao, Jin

    (Norges Bank)

  • Chollete, Loran

    (UiS)

Abstract
We present a framework for modelling optimum capital adequacy in a dynamic banking context. We combine the (static) capital adequacy framework of Repullo (2013) with a dynamic banking model similar to that of Corbae and D`Erasmo (2014), with the extra feature that the probability of systemic risk is endogenous. Unlike previous work, we examine frameworks to ameliorate bankruptcy using both capital adequacy and liquidity requirements. Since equity is costly, the social cost of regulation may be reduced if a regulatory capital requirement can be accompanied by other tools such as a liquidity buffer.

Suggested Citation

  • Cao, Jin & Chollete, Loran, 2014. "Capital Adequacy and Liquidity in Banking Dynamics: Theory and Regulatory Implications," UiS Working Papers in Economics and Finance 2014/16, University of Stavanger.
    • Handle: RePEc:hhs:stavef:2014_016
    as

    Download full text from publisher

    File URL: https://dl.dropboxusercontent.com/u/8078351/uis_wps_econ_fin/uis_wps_2014_16_cao_chollete.pdf
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    References listed on IDEAS

    as
    1. Dean Corbae & Pablo D'Erasmo, 2014. "Capital requirements in a quantitative model of banking industry dynamics," Working Papers 14-13, Federal Reserve Bank of Philadelphia.
    2. Franklin Allen & Elena Carletti & Robert Marquez, 2011. "Credit Market Competition and Capital Regulation," The Review of Financial Studies, Society for Financial Studies, vol. 24(4), pages 983-1018.
    3. Jin Cao & Gerhard Illing, 2011. ""Interest rate trap", or: Why does the central bank keep the policy rate too low for too long time?," Working Paper 2011/12, Norges Bank.
    4. Valeriya Dinger & Francesco Vallascas, 2014. "Are Banks Less Likely to Issue Equity When They Are Less Capitalized?," IEER Working Papers 100, Institute of Empirical Economic Research, Osnabrueck University.
    5. Repullo, Rafael, 2013. "Cyclical adjustment of capital requirements: A simple framework," Journal of Financial Intermediation, Elsevier, vol. 22(4), pages 608-626.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Keywords: Bankruptcy; Capital Adequacy; Endogenous Systemic Risk; Liquidity Requirement; Regulation Costs;
    All these keywords.

    JEL classification:

    • E50 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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