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.
Credit fluctuations; Macroprudential regulation; Sectoral misallocation of capital;
- D86: Economics of Contract: Theory
- G21: Banks • Depository Institutions • Micro Finance Institutions • Mortgages
- G28: Government Policy and Regulation
Journal of Monetary Economics, vol. 90, 2017, p. 113–124