Abstract
We show that risk-based capital requirements can eliminate the market failure, caused by asymmetric information between entrepreneurs and banks, which distorts the efficient allocation of low-risk and high-risk investment projects among entrepreneurs. If project success probabilities decline in recessions, optimal capital requirements will have to be lower because the size of the market failure changes. This provides a new rationale for keeping risk-based capital requirements higher in good times and lowering them in bad times.
| Original language | English |
|---|---|
| Pages (from-to) | 55-76 |
| Number of pages | 22 |
| Journal | JOURNAL OF FINANCIAL SERVICES RESEARCH |
| Volume | 46 |
| Issue number | 1 |
| DOIs | |
| Publication status | Published - 2014 |
| MoE publication type | A1 Journal article-refereed |
Keywords
- Bank regulation
- Basel III
- Capital requirements
- Credit risk
- Crises
- Procyclicality