Risky Bank Lending and Optimal Capital Adequacy Regulation

June 1, 2011

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Jaromir Benes, and Michael Kumhof. Risky Bank Lending and Optimal Capital Adequacy Regulation, (USA: International Monetary Fund, 2011) accessed November 12, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We study the welfare properties of a New Keynesian monetary economy with an essential role for risky bank lending. Banks lend funds deposited by households to a financial accelerator sector, and face penalties for maintaining insufficient net worth. The loan contract specifies an unconditional lending rate, which implies that banks can make loan losses. Their main response is to raise lending rates to rebuild net worth. Prudential rules that adjust minimum capital adequacy requirements in response to loan losses significantly increase welfare. But the gains from eliminating limited liability and moral hazard would be an order of magnitude larger.

Subject: Bank credit, Banking, Capital adequacy requirements, Central bank policy rate, Financial institutions, Financial regulation and supervision, Financial services, Loans, Mutual funds, Stocks

Keywords: Adequacy regulation, Bank capital, Bank capital adequacy, Bank lending, Bank net worth, Capital adequacy requirements, Capital goods, Capital investment, Capital investment investment funds, Central bank policy rate, Debt contract, Financial accelerator, Interest rate, Lending risk, Loan gap, Loan loss, Loans, Mutual funds, Optimal monetary policy, Optimal prudential policy, Optimization problem, Recovery rate, Shock bank, Steady state bank equity, Stocks, Welfare analysis, WP

Publication Details

Pages:

27
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2011/130
Stock No:

WPIEA2011130
ISBN:

9781455259359
ISSN:

1018-5941

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