Working Paper: CEPR ID: DP13248
Authors: David Martinez-Miera; Rafael Repullo
Abstract: We analyze the effect of bank capital requirements on the structure and risk of a financial system where markets, regulated banks, and shadow banks coexist. Banks face a moral hazard problem in screening entrepreneurs' projects, and they choose whether to be regulated or not. If regulated, a supervisor certifies their capital; if not, they have to rely on more expensive private certification. Under both risk-insensitive and risk-sensitive requirements, safer entrepreneurs borrow from the market and riskier entrepreneurs borrow from banks. But risk-insensitive (sensitive) requirements are especially costly for relatively safe (risky) entrepreneurs, which may shift from regulated to shadow banks.
Keywords: bank regulation; bank supervision; capital requirements; credit screening; credit spreads; loan defaults; optimal regulation; market finance; shadow banks
JEL Codes: G21; G23; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk-insensitive capital requirements (G28) | shift of lending from regulated banks to shadow banks (G21) |
| risk-sensitive capital requirements (G28) | screening incentives (M52) |
| screening incentives (M52) | risk profiles of loans (G21) |
| risk-sensitive capital requirements (G28) | shift of borrowing from regulated banks to shadow banks (F65) |
| shift of borrowing from regulated banks to shadow banks (F65) | higher overall risk in the financial system (F65) |
| tightening capital requirements (G28) | screening incentives for banks (G21) |
| tightening capital requirements (G28) | transition to shadow banks (F65) |
| transition to shadow banks (F65) | risk of defaults among borrowers (G21) |
| risk-sensitive capital requirements (G28) | overall risk of the financial system (F65) |