Bank capital and liquidity regulation

Abstract

Since the global financial crisis, banking regulations have become more stringent and complex. In particular, capital and liquidity adequacy requirements have been discussed extensively in various contexts. This study constructs a general equilibrium model that incorporates banks and households that hold both liquid and illiquid assets to compare the economic effects of capital and liquidity adequacy requirements. Simulations show that liquidity regulation in the style of current the Basel Accord, as well as capital regulation, reduces the probability of financial crisis after a recession, not only by restricting banks’ leverage, but also by aiding the recovery of asset prices.