Working Paper: NBER ID: w24757
Authors: Vadim Elenev; Tim Landvoigt; Stijn Van Nieuwerburgh
Abstract: How much capital should financial intermediaries hold? We propose a general equilibrium model with a financial sector that makes risky long-term loans to firms, funded by deposits from savers. Government guarantees create a role for bank capital regulation. The model captures the sharp and persistent drop in macro-economic aggregates and credit provision as well as the sharp change in credit spreads observed during the Great Recession. Policies requiring intermediaries to hold more capital reduce financial fragility, reduce the size of the financial and non-financial sectors, and locally increase macro-economic volatility. They redistribute wealth from savers to the owners of banks and non-financial firms. Current capital requirements are close to optimal.
Keywords: No keywords provided
JEL Codes: E02; E1; E20; E44; E6; G12; G18; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increasing bank capital requirements from 6% to higher levels (G28) | Reduces financial fragility (G59) |
| Higher capital requirements (G28) | Reduction in the size of both the financial and nonfinancial sectors (G29) |
| Higher capital requirements (G28) | Increases local macroeconomic volatility (E39) |
| Higher capital requirements (G28) | Decrease in likelihood of bank failures (G28) |
| Higher capital requirements (G28) | Economic shrinkage (F69) |