Working Paper: CEPR ID: DP7819
Authors: Hans Gersbach; Volker Hahn
Abstract: In this paper, we introduce a new requirement for bank capital: banking-on-the-average rules. Under these rules a bank?s required level of equity capital is monotonically increasing in the realized equity capital of its peers. In a simple model we illustrate the workings of banking-on-the-average rules. We show that in booms these rules can prevent banks from taking excessive risks. Moreover, they alleviate the socially harmful procyclicality of conventional equity-capital rules, which may induce banks to cut back excessively on lending. Finally, we argue that under these rules prudent banks can impose prudency on other banks. In addition, banking-on-the-average rules ensure the build-up of bank equity capital in booms and thus avoid excessive leverage.
Keywords: banking crisis; banking on the average; banking system; equity capital requirements
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| BOA rules (G28) | reduction in excessive risk-taking (D91) |
| higher required equity ratios (G32) | reduced risk-taking (D91) |
| BOA rules (G28) | alleviate socially harmful procyclicality (E44) |
| BOA rules (G28) | maintain higher capital levels (G32) |
| maintain higher capital levels (G32) | avoid liquidation of long-term investments (G33) |