Abstract
The credit risk that an individual bank poses to the rest of the financial system depends on its size, the type of exposures it has to the real economy, and its obligations to other institutions. This paper describes a system-wide risk management approach to calibrating individual banks’ capital requirements that takes into account these factors and which correspond to a policymaker’s chosen target for systemic credit risk. The optimization strategy identifies the minimum level of aggregate capital for the system and its distribution across banks that are consistent with a chosen objective for systemic credit risk. This parameterizes a trade-off between efficiency and stability.
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