Article

Capital Regulation and Credit Fluctuations

Hans Gersbach, and Jean-Charles Rochet

Abstract

Credit cycle stabilization can be a rationale for imposing counter-cyclical capital requirements on banks. The model comprises two productive sectors: in one sector, firms can finance investments through a bond market. In the other, firms rely on bank credit. Financial frictions limit banks’ borrowing capacity. Aggregate shocks impact firms’ productivity. From a welfare perspective, banks lend too much in high productivity states and too little in bad states, although financial markets are complete. Imposing a (stricter) capital requirement in good states corrects capital misallocation, increases expected output and social welfare. Even with risk-neutral agents, stabilization of credit cycles is socially beneficial.

Keywords

Credit fluctuations; Macroprudential regulation; Sectoral misallocation of capital;

JEL codes

  • D86: Economics of Contract: Theory
  • G21: Banks • Depository Institutions • Micro Finance Institutions • Mortgages
  • G28: Government Policy and Regulation

Reference

Hans Gersbach, and Jean-Charles Rochet, Capital Regulation and Credit Fluctuations, Journal of Monetary Economics, vol. 90, 2017, pp. 113–124.

Published in

Journal of Monetary Economics, vol. 90, 2017, pp. 113–124