Bank Capital Regulation and Credit Supply

Abstract

For the increase of the bank capital adequacy ratio, banks can meet this requirement either by issuing new equity or by reducing loan. With a simple model with banks, we try to show two things. (i) If a bank's decision is made for the benefit of the incumbent shareholders, it may reduce risky loan for the new capital regulation even though it can re-capitalize by selling new equity to the public. (ii) If all the banks do so, there happens net deposit withdrawal, which may cause a further shrinkage of credit supply. A simple heuristic calibration with Korean data shows that these results may hold in a reasonable parameter value range.