Open Access Journal Article

Do Bank Capital Requirements Make Resource Allocation Suboptimal?

by Sangkyun Park a,b,* orcid
a
The U.S. Office of Management and Budget, USA
b
Federal Reserve Banks (New York and Saint Louis), USA
*
Author to whom correspondence should be addressed.
JEA  2022 1(2):11; https://doi.org/10.58567/jea01020003
Received: 11 December 2022 / Accepted: 19 December 2022 / Published Online: 21 December 2022
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Abstract

Bank capital requirements would entail large social costs if they made resource allocation suboptimal and banking services costly by unduly limiting the banks’ ability to lend. This paper considers three main factors that may make capital requirements relevant, namely, deposit insurance subsidies, stock valuation errors, and tax shields derived from debt financing. The theoretical model analyzes the combined effects of the three factors on the banks’ incentives to make fairly priced loans, which should also be socially optimal loans. A key finding is that the long-term cost of capital requirements is likely to be very small when deposit insurance is underpriced. Increased funding costs resulting from higher capital requirements are absorbed by shareholders of banks, rather than passed on to borrowers. Under some reasonable assumptions, higher capital requirements improve resource allocation by countervailing distortionary effects of deposit insurance subsidies. Short-term adjustment costs can still be large, but it should be relatively easy to mitigate the short-term effects.

Keywords: Costs of Capital Requirements; Deposit Insurance; Stock mispricing; Tax shields;
Copyright: © 2022 by Park. This is an open-access article distributed under the terms of the Creative Commons Attribution License (CC BY) (Creative Commons Attribution 4.0 International License). The use, distribution or reproduction in other forums is permitted, provided the original author(s) or licensor are credited and that the original publication in this journal is cited, in accordance with accepted academic practice. No use, distribution or reproduction is permitted which does not comply with these terms.

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ACS Style
Park, S. Do Bank Capital Requirements Make Resource Allocation Suboptimal?. Journal of Economic Analysis, 2022, 1, 11. https://doi.org/10.58567/jea01020003
AMA Style
Park S. Do Bank Capital Requirements Make Resource Allocation Suboptimal?. Journal of Economic Analysis; 2022, 1(2):11. https://doi.org/10.58567/jea01020003
Chicago/Turabian Style
Park, Sangkyun 2022. "Do Bank Capital Requirements Make Resource Allocation Suboptimal?" Journal of Economic Analysis 1, no.2:11. https://doi.org/10.58567/jea01020003
APA style
Park, S. (2022). Do Bank Capital Requirements Make Resource Allocation Suboptimal?. Journal of Economic Analysis, 1(2), 11. https://doi.org/10.58567/jea01020003

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