Essays on Banking Regulations

Abstract

Recent banking regulations have for the first time introduced liquidity standards, under which banks are required to hold a certain proportion of their portfolio in form of safe liquid assets. This dissertation quantitatively evaluates the macroeconomic effects of such regulations in a model with a banking sector and endogenous liquidity risk. In the model, banks raise deposits to invest in safe government bond and risky equity claims on capital with endogenous fire sale episodes which occur due to bank runs. Such runs arise because banks finance their assets with non-contingent short-term deposits. Liquidity regulation has the direct effect of reducing the likelihood and severity of bank runs for any given level of leverage, but also has an offsetting indirect effect of raising leverage and increasing the likelihood of a run. I show that regulation has the overall benefits of making bank runs less likely because the direct effect outweighs the indirect effect. Furthermore, liquidity regulation has costs because it leads to inefficient intermediation and crowding out of productive capital. I show that the overall welfare impact of these regulations depends on the extent of fire sales and the severity of financial frictions. Calibrating the model to match salient features of US economy, I quantify the optimal level of liquidity regulations, and their effect on the probability of bank run and their overall welfare effect.