Why Do We Need Countercyclical Capital Requirements?

Esa Jokivuolle*, Ilkka Kiema, Timo Vesala

*Corresponding author for this work

Research output: Contribution to journalArticleScientificpeer-review

2 Citations (Scopus)

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 languageEnglish
Pages (from-to)55-76
Number of pages22
JournalJOURNAL OF FINANCIAL SERVICES RESEARCH
Volume46
Issue number1
DOIs
Publication statusPublished - 2014
MoE publication typeA1 Journal article-refereed

Keywords

  • Bank regulation
  • Basel III
  • Capital requirements
  • Credit risk
  • Crises
  • Procyclicality

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