The Shadow Cost of Bank Capital Requirements

Abstract

We estimate the shadow cost of capital requirements using data on a costly loophole that allowed banks to relax these constraints. This loophole — liquidity guarantees to asset-backed commercial paper conduits — was exploited by the largest banks before the crisis of 2008. We show theoretically that a bank's use of the loophole reveals its private compliance cost, which takes into account both the costs of issuing equity and the effectiveness of capital regulation. We find that increasing capital requirements would impose a modest cost — $220 million a year for all participating banks combined per 1pp increase, and $14 million on average.

Keywords: Financial intermediation, Bank capital requirements, Cost of capital regulation, Leverage, Regulatory Arbitrage, Loophole

JEL Classification: G21, G28, G18, L51, G32