Why Do We Need Countercyclical Capital Requirements?

Ilkka Kiema, Esa Jokivuolle, Timo Vesala

Research output: Contribution to journalArticleScientificpeer-review


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
JournalJournal of Financial Services Research
Issue number1
Pages (from-to)55-76
Number of pages22
Publication statusPublished - 2014
MoE publication typeA1 Journal article-refereed

Fields of Science

  • 511 Economics
  • Bank regulation, Basel III, Capital requirements, Credit risk, Crises, Procyclicality

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