Capital Buﬀers in a Quantitative Model of Banking Industry Dynamics
Abstract: We develop a model of banking industry dynamics to study the quantitative impact of regulatory policies on bank risk taking and market structure as well as the feedback eﬀect of market structure on the eﬃcacy of policy. Since our model is matched to U.S. data, we propose a market structure where big banks with market power interact with small, competitive fringe banks. Banks face idiosyncratic funding shocks in addition to aggregate shocks which aﬀect the fraction of performing loans in their portfolio. A nontrivial bank size distribution arises out of endogenous entry and exit, as well as banks’ buﬀer stock of net worth. We show the model predictions are consistent with untargeted business cycle properties, the bank lending channel, and empirical studies of the role of concentration on ﬁnancial stability. We then conduct a series of policy counterfactuals motivated by those proposed in the Dodd-Frank Act (size and state dependent capital requirements and liquidity requirements). We ﬁnd that regulatory policies can have an important impact on banking market structure, which, along with selection eﬀects, can generate changes in allocative eﬃciency and stability.
File(s): File format is text/html https://www.philadelphiafed.org/-/media/frbp/assets/working-papers/2021/wp21-24.pdf
Provider: Federal Reserve Bank of Philadelphia
Part of Series: Working Papers
Publication Date: 2021-06-11
Note: Supersedes Working Paper 14-13 – Capital Requirements in a Quantitative Model of Banking Industry Dynamics