Welfare analysis of bank capital requirements with endogenous default

12 June 2017
Publication Type: Working Paper
Economic Theme: Public Finance
JEL Code: E44, E47, E58, G28
This paper presents a tractable framework with endogenous default and evaluates the welfare implication of bank capital requirements. We analyze the response of social welfare to a negative technology shock under different capital requirement regimes with and without default. We show that including default as an additional indicator of capital requirements is welfare improving. When implementing capital requirements, a more aggressive reaction to the default rate is more effective for weakening the negative effect of the shock on welfare. Compared with output gap, the credit-to-output gap is a better indicator for implementing the countercyclical capital buffer.
Working paper 688
1 June 2017
Journal: Economic Modelling
1 June 2018