More Equity, Fewer Deposits? The Elusive Effect of Capital Requirements on Bank Debt

Abstract

Prior literature suggests that higher equity capital requirements for banks might lead to a socially costly reduction in deposits and other liquid bank liabilities. This paper presents a model of bank capital structure in which the effect of more-stringent capital requirements on the supply of deposits can be non-monotonic. A small rise in capital requirements from low levels can, in some cases, inefficiently crowd out deposits. However, a more substantial tightening, by making banks significantly safer, may not only reverse this effect, but may also cause banks to accept more deposits than they would in the absence of capital requirements.