Working Paper: CEPR ID: DP14055
Authors: Ester Faia
Abstract: This paper studies the optimal design of equity and liquidity regulations in a dynamic macro model with information-based bank runs. Although the latter are privately efficient, since they discipline bank managers efforts into the projects' re-deploying activity, they induce aggregate externalities. Technological inefficiencies arise if bank managers extract rents which are higher than the technological costs of re-deploying projects. Pecuniary externalities arise since, when choosing leverage, bank managers do not internalize the fall in asset price ensuing from the aggregate costs of projects' liquidation in a run event. This creates scope for regulation. Equity and liquidity requirements are complementary, as the first tackles the solvency region, while the second the illiquid-solvent one. Finally, in presence of anticipatory effects prudential policies may have unintended consequences as banks adjust their behaviour when a shift in prudential regime is announced. The more so the higher the credibility of the announcement.
Keywords: information-based bank runs; pecuniary externalities; Ramsey plan; Basel regimes; equity requirements; liquidity requirements
JEL Codes: E0; E5; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Bank runs (E44) | technological inefficiencies (O33) |
| Leverage choices by bank managers (G21) | fall in asset prices (G19) |
| Equity requirements (G12) | Liquidity requirements (G28) |
| Regulatory announcements (G38) | bank behavior (G21) |
| bank behavior (G21) | effectiveness of regulations (L51) |