257 - Capital Requirements and Credit Rationing

DNB Working Papers
Date 10 August 2010

This paper analyzes the trade-off between financial stability and credit rationing that arises when increasing capital requirements. It extends the Stiglitz-Weiss model of credit rationing to allow for bank default. Bank capital structure then matters for lending incentives. With default and rationing endogenous, optimal capital requirements can be analyzed. Introducing bank financiers, the paper also shows that uninsured funding raises the sensitivity of rationing to capital requirements. In a world with much wholesale finance, capital requirements have a stronger impact on the real economy. But wholesale finance also amplifies capital requirements’ effect on default rates.

Keywords: Rationing, Capital requirements, Regulation, Wholesale finance, Deposit Insurance.

JEL Classification: G21, G28.