Capital%20Requirements%2C%20Risk%2DTaking%20and%20Welfare%20in%20a%20Growing%20Economy

Working Papers

Capital Requirements, Risk-Taking and Welfare in a Growing Economy


CODE: IDB-WP-771
AUTHOR(s): Agénor, Pierre-Richard , Pereira da Silva, Luiz A.
PUBLISHED: March 2017
LANGUAGE: English
RELATED TOPICS: Finance
DOWNLOAD FILE IN: English

Abstract:

The effects of capital requirements on risk-taking and welfare are studied in a stochastic overlapping generations model of endogenous growth with banking, limited liability, and government guarantees. Capital producers face a choice between a safe technology and a risky (but socially inefficient) technology, and bank risk-taking is endogenous. Setting the capital adequacy ratio above a structural threshold can eliminate the equilibrium with risky loans (and thus inefficient risk-taking), but numerical simulations show that this may entail a welfare loss. In addition, the optimal ratio may be too high in practice and may concomitantly require a broadening of the perimeter of regulation and a strengthening of financial supervision to prevent disintermediation and distortions in financial markets.

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