Work

Rules versus discretion in capital regulation

Year: 2025

Type: article

Abstract: We study capital regulation in a dynamic model for bank deposits. Capital regulation addresses banks’ incentive for excessive leverage that dilutes depositors, but preserves some dilution to reduce bank defaults. We show theoretically that capital regulation is subject to a time inconsistency problem. In a model with non-maturing deposits where optimal withdrawals make deposits endogenously long-term, we find commitment to have important effects on the optimal level and cyclicality of capital adequacy. Our results call for a systematic framework that limits capital regulators’ discretion.

Source: Journal of Financial Economics

DOI: 10.1016/j.jfineco.2025.104060

Authors: Urban Jermann, Haotian Xiang

Institutions: National Bureau of Economic Research, University of Pennsylvania, Peking University

Language: English

Topic: Banking stability, regulation, efficiency

Subfield: Finance

Field: Economics, Econometrics and Finance

Domain: Social Sciences

Open Access status: hybrid

Estimated APC paid: $4,740

OpenAlex ID: W4409212928

FWCI: 4.695

Cites: 54

Cited by: 5

Related to: 10