The Forced Safety Effect: How Higher Capital Requirements Can Increase Bank Lending
Corresponding Author
SALEEM BAHAJ
Correspondence: Saleem Bahaj, Bank of England (BoE). e-mail: saleembahaj@gmail.com
Search for more papers by this authorFREDERIC MALHERBE
Saleem Bahaj is at the Bank of England (BoE). Frederic Malherbe is at the University College London. We are indebted to the Editor Philip Bond, the Associate Editors, and two anonymous referees. A previous version was circulated under the title: “A Positive Analysis of Bank Behaviour under Capital Requirements.” This paper drew extensively on the BoE Staff Working Paper (Bahaj et al. (2016)) that we wrote with Jonathan Bridges and Cian O'Neill. We thank them for their contribution and for allowing us to build off this previous work. We are particularly grateful to Jason Donaldson, and to Kartik Anand, Heski Bar-Isaak, Max Bruche, Matthieu Chavaz, Filippo de Marco, Stijn Ferarri, Peter Feldhutter, Pablo Alberto Aguilar Garcia, Tirupam Goel, Sebastian Hohmann, David Martinez-Miera, Caterina Mendicino, Tom Norman, Marcus Opp, Daniel Paravisini, Jose-Luis Peydro, Helene Rey, Oleg Rubanov, Carmelo Salleo, Javier Suarez, and Emily Williams for their discussions and comments. We also thank numerous seminar and conference participants for their feedback. The views expressed here are those of the authors and do not necessarily reflect those of the BoE or its policy committees. We have read The Journal of Finance disclosure policy and have no conflicts of interest to disclose.
Search for more papers by this authorCorresponding Author
SALEEM BAHAJ
Correspondence: Saleem Bahaj, Bank of England (BoE). e-mail: saleembahaj@gmail.com
Search for more papers by this authorFREDERIC MALHERBE
Saleem Bahaj is at the Bank of England (BoE). Frederic Malherbe is at the University College London. We are indebted to the Editor Philip Bond, the Associate Editors, and two anonymous referees. A previous version was circulated under the title: “A Positive Analysis of Bank Behaviour under Capital Requirements.” This paper drew extensively on the BoE Staff Working Paper (Bahaj et al. (2016)) that we wrote with Jonathan Bridges and Cian O'Neill. We thank them for their contribution and for allowing us to build off this previous work. We are particularly grateful to Jason Donaldson, and to Kartik Anand, Heski Bar-Isaak, Max Bruche, Matthieu Chavaz, Filippo de Marco, Stijn Ferarri, Peter Feldhutter, Pablo Alberto Aguilar Garcia, Tirupam Goel, Sebastian Hohmann, David Martinez-Miera, Caterina Mendicino, Tom Norman, Marcus Opp, Daniel Paravisini, Jose-Luis Peydro, Helene Rey, Oleg Rubanov, Carmelo Salleo, Javier Suarez, and Emily Williams for their discussions and comments. We also thank numerous seminar and conference participants for their feedback. The views expressed here are those of the authors and do not necessarily reflect those of the BoE or its policy committees. We have read The Journal of Finance disclosure policy and have no conflicts of interest to disclose.
Search for more papers by this authorABSTRACT
Government guarantees generate an implicit subsidy for banks. A capital requirement reduces this subsidy, through a simple liability composition effect. However, the guarantees also make a bank undervalue loans that generates surplus in states of the world in which it defaults. Raising the capital requirement makes the bank safer, which alleviates this problem. We refer to this mechanism, which we argue is empirically relevant, as the forced safety effect.
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