Credit Allocation, Capital Requirements and Output

Jokivuolle, Esa; Kiema, Ilkka; Vesala, Timo

doi:10.2139/ssrn.1755090

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Credit Allocation, Capital Requirements and Output

Bank of Finland Research Discussion Paper No. 17/2010

38 Pages Posted: 5 Feb 2011

See all articles by Esa Jokivuolle

Timo Vesala

Tapiola Group

Date Written: December 15, 2010

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.

This version updates the Bank of Finland Discussion Paper 23/2009, 'Credit Allocation, Capital Requirements and Procyclicality.'

Keywords: Bank Regulation, Basel III, Capital Requirements, Credit Risk, Crises, Procyclicality

JEL Classification: D41, D82, G14, G21, G28

Suggested Citation: Suggested Citation

Jokivuolle, Esa and Kiema, Ilkka and Vesala, Timo, Credit Allocation, Capital Requirements and Output (December 15, 2010). Bank of Finland Research Discussion Paper No. 17/2010, Available at SSRN: https://ssrn.com/abstract=1755090 or http://dx.doi.org/10.2139/ssrn.1755090