Working Paper: CEPR ID: DP4148
Authors: Gyngyi Lrnth; Alan Morrison
Abstract: We analyse a model in which bank deposits are insured and there is an exogenous cost of bank capital. The former effect results in bank over-investment and the latter in under-investment. Regulatory capital requirements introduce investment distortions, which are a constrained optimal response to these market imperfections. We show that capital requirements which are constrained optimal for national banks result in under-investment by multinational banks. The extent of under-investment depends upon the home bank?s riskiness, the extent of international diversification, and the liability structure (branch or subsidiary) of the multinational. Capital requirements for international banks should therefore reflect these effects. We relate our findings to observed features of multinational banks and we discuss the possible existence of a multinational bank channel for financial contagion.
Keywords: capital adequacy requirements; deposit insurance; multinational bank
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital requirements (G32) | underinvestment (G31) |
| national capital requirements (G28) | higher hurdle rate for investments in foreign branches (F23) |
| higher risk of home bank (G21) | greater reduction in investment levels (G11) |
| increased volatility in home bank's assets (F65) | impact on investment decisions in foreign banks (F65) |
| capital requirements (G32) | impact on investment behaviors in multinational banks (F23) |
| deposit insurance (G28) | underinvestment in multinational banks (F23) |