Credit Allocation, Capital Requirements and Output

5.6.2010 Työpapereita Ilkka Kiema, Esa Jokivuolle, Timo Vesala

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.

Julkaisun tiedot

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