Capital Requirements, Risk-Taking and Welfare in a Growing Economy
The effects of capital requirements on risk-taking and welfare are studied in a stochastic overlapping generations model of endogenous growth with banking, limited liability, and government guarantees. Capital producers face a choice between a safe technology and a risky (but socially inefficient) technology, and bank risk-taking is endogenous. Setting the capital adequacy ratio above a structural threshold can eliminate the equilibrium with risky loans (and thus inefficient risk-taking), but numerical simulations show that this may entail a welfare loss. In addition, the optimal ratio may be too high in practice and may concomitantly require a broadening of the perimeter of regulation and a strengthening of financial supervision to prevent disintermediation and distortions in financial markets.
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| Format: | Working Papers biblioteca |
| Language: | English |
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Inter-American Development Bank
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| Subjects: | Capital Requirement, Bank Risk-Taking, Investment, Economic Development, Capital Goods, Financial Regulation, Financial Market, E44 - Financial Markets and the Macroeconomy, G28 - Government Policy and Regulation, O41 - One Two and Multisector Growth Models, risky investments;financial stability;financial regulation, |
| Online Access: | http://dx.doi.org/10.18235/0011782 https://publications.iadb.org/en/capital-requirements-risk-taking-and-welfare-growing-economy |
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| Summary: | The effects of capital requirements on risk-taking and welfare are studied in a stochastic overlapping generations model of endogenous growth with banking, limited liability, and government guarantees. Capital producers face a choice between a safe technology and a risky (but socially inefficient) technology, and bank risk-taking is endogenous. Setting the capital adequacy ratio above a structural threshold can eliminate the equilibrium with risky loans (and thus inefficient risk-taking), but numerical simulations show that this may entail a welfare loss. In addition, the optimal ratio may be too high in practice and may concomitantly require a broadening of the perimeter of regulation and a strengthening of financial supervision to prevent disintermediation and distortions in financial markets. |
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