Working Paper: CEPR ID: DP3253
Authors: Viral V. Acharya
Abstract: The merit of having international convergence of bank capital requirements in the presence of divergent closure policies of different central banks is examined. While the privately optimal level of bank capital decreases with regulatory forbearance (they are strategic substitutes), the socially optimal level of bank capital increases with regulatory forbearance (they are strategic complements). Hence, in optimal regulatory design, the level of minimum bank capital requirement increases with the forbearance in central bank closure policy. The lack of such linkage leads to a spillover from more forbearing to less forbearing economies and reduces the competitive advantage of banks in less forbearing economies. Linking the central bank?s forbearance to its alignment with domestic bankowners, it is shown that in equilibrium a regression towards the worst closure policy may result: the central banks of initially less forbearing economies have to adopt greater forbearance as well.
Keywords: bank regulation; capital adequacy; closure policy; financial integration; international spillovers; risk-shifting
JEL Codes: D62; E58; G21; G28; G38
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| regulatory forbearance (G28) | privately optimal level of bank capital (G21) |
| regulatory forbearance (G28) | socially optimal level of bank capital (G21) |
| closure policies (G33) | regulatory standards (L98) |
| capital requirements (G32) | closure policies (G33) |
| regulatory forbearance (G28) | minimum capital requirement (G32) |
| convergence in capital adequacy regulation (G18) | negative spillovers across countries (F69) |