On the Effectiveness of Capital Requirements

digital

Article

Magazine

RIVISTA INTERNAZIONALE DI SCIENZE SOCIALI

Fascicle

RIVISTA INTERNAZIONALE DI SCIENZE SOCIALI - 2023 - 1. A special issue in honor of Gerd Weinrich

Title

On the Effectiveness of Capital Requirements

Authors

Gevorg Hunanyan, Jan Wenzelburger

Publisher

Vita e Pensiero

Format

Article |

Pdf

Online from

05-2023

Doi

10.26350/000518_000115

Issn

0035-676X (print) | 1827-7918 (digital)

€ 6.00

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Description

This article demonstrates that the effectiveness of capital requirements in reducing default risk depends on the risk-taking behaviour of financial intermediaries. Capital requirements with risk weights that are not proportional to expected excess returns create adverse incentives that may lead to an increase in default risk through short-sales. We establish the coefficient of variation of future net worth as a measure of default risk and show that non-proportional risk weights can never be calibrated such that all intermediaries reduce default risk. Since default risk depends non-linearly on equity, it will increase with higher equity and thus with inappropriately chosen capital coefficients whenever the willingness to assume risk is sufficiently elastic.

keywords

Capital requirements, default risk, financial intermediation, banking regulation

Authors biography

Gevorg Hunanyan, Jan Wenzelburger, Fachbereich Wirtschaftswissenschaften - RPTU Kaiserslautern-Landau - Postfach 3049, 67663 Kaiserslautern, Germany. Email Hunanyan: gevorg.hunanyan@gmail.com
gevorg.hunanyan@gmail.com. Email Wenzelburger: jan.wenzelburger@rptu.de.