Scandinavian Working Papers in Economics

UiS Working Papers in Economics and Finance,
University of Stavanger

No 2014/16: Capital Adequacy and Liquidity in Banking Dynamics: Theory and Regulatory Implications

Jin Cao and Loran Chollete ()
Additional contact information
Jin Cao: Norges Bank
Loran Chollete: UiS, Postal: University of Stavanger, NO-4036 Stavanger, Norway

Abstract: We present a framework for modelling optimum capital adequacy in a dynamic banking context. We combine the (static) capital adequacy framework of Repullo (2013) with a dynamic banking model similar to that of Corbae and D`Erasmo (2014), with the extra feature that the probability of systemic risk is endogenous. Unlike previous work, we examine frameworks to ameliorate bankruptcy using both capital adequacy and liquidity requirements. Since equity is costly, the social cost of regulation may be reduced if a regulatory capital requirement can be accompanied by other tools such as a liquidity buffer.

Keywords: Keywords: Bankruptcy; Capital Adequacy; Endogenous Systemic Risk; Liquidity Requirement; Regulation Costs

JEL-codes: E50; G21; G28

17 pages, September 16, 2014

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