Credit Allocation, Capital Requirements and Output (Jokivuolle E., Kiema I., Vesala T.)

Basel I-III Information Asymmetry and Transparency Regulation Risk-taking and Risk Management

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.

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Libref/ Jokivuolle E., Kiema I., Vesala T. (2010) "Credit Allocation, Capital Requirements and Output", Bank of Finland Research Discussion Paper No. 17/2010, pp. 1 - 38
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