Macroprudential Bank Capital Regulation in a Competitive Financial System∗

We propose a tractable general equilibrium framework to analyze the effectiveness of bank capital regulations when banks face competition from public markets. Our analysis shows that increased competition can not only render previously optimal bank capital regulations ineffective but also imply that, over some ranges, increases in capital requirements cause more banks to engage in value-destroying risk-shifting. Our model generates a set of novel implications that highlight the dependencies between optimal bank capital regulation and the comparative advantages of various players in the financial system. ∗We are grateful to Anat Admati, Michael Brennan, Elena Carletti, Sam Lee, Giorgia Piacentino, Matt Spiegel and Jeremy Stein for thoughtful discussions of earlier drafts of this paper as well as Valerie Chen and Peter DeMarzo for helpful comments. In addition, we thank seminar participants at the NBER SI 2014, the Berkeley-Stanford joint seminar, the University of Chicago, the Bundesbank, the Federal Reserve Bank of New York and the Federal Reserve Board of Governors. †University of Chicago, Booth School of Business, e-mail: [email protected]. Professor Harris thanks the Center for Research in Security Prices at the University of Chicago Booth School of Business for financial support. ‡University of Pennsylvania, The Wharton School, email: [email protected]. Research support from the Rodney White Center for Financial Research and the Wharton School Dean’s Research Fund is gratefully acknowledged. §University of California, Berkeley (Haas), email: [email protected].