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 |
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Journal | Journal of Financial Services Research |
Volume | 46 |
Issue number | 1 |
Pages (from-to) | 55-76 |
Number of pages | 22 |
ISSN | 0920-8550 |
DOIs | |
Publication status | Published - 2014 |
MoE publication type | A1 Journal article-refereed |
Fields of Science
- 511 Economics
- Bank regulation, Basel III, Capital requirements, Credit risk, Crises, Procyclicality