Scandinavian Working Papers in Economics
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Bank of Finland Research Discussion Papers, Bank of Finland

No 17/2010:
Credit allocation, capital requirements and output

Esa Jokivuolle (), Ilkka Kiema () and Timo Vesala ()

Abstract: We show how banks’ excessive risk-taking, stemming from informational asymmetries in loan markets, can lead to an excessive output loss when a recession starts. Risk-based capital requirements can alleviate the output loss by reducing excessive risk-taking in ‘normal’ times. Model simulations suggest that the differentiation of risk-weights in the Basel framework might be further increased in order to take full advantage of the allocational effects of capital requirements. Our analysis also provides a new rationale for the countercyclical elements of capital requirements.

Keywords: bank regulation; Basel III; capital requirements; credit risk; crises; procyclicality; (follow links to similar papers)

JEL-Codes: D41; D82; G14; G21; G28; (follow links to similar papers)

35 pages, December 1, 2010

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This paper is forthcoming as:
Jokivuolle, Esa, Ilkka Kiema and Timo Vesala, 'Credit allocation, capital requirements and output', Journal of Financial Services Research.

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