Credit Allocation, Capital Requirements and Output

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.

Publication information

Kiema, I., Jokivuolle, E., & Vesala, T. (2010),  Credit allocation, capital requirements and output, Bank of Finland Research Discussion Papers 17/2010, Bank of Finland.

• ISSN: 0785-3572 (Print), 1456-6184 (Online)
• ISBN: 978-952-462-618-7 (Print), 978-952-462-619-4 (Online)
• JEL: D41, D82, G14, G21, G28