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Following a decline in the fundamental risk of assets, the ability of banks to expand the balance sheet under a Value-at-Risk constraint in- creases as in Adrian and Shin 2010, boosting the bank’s incentives to provide costly monitoring effort that prevents asset deterioration. On the other hand, high asset demand and prices, eventually, raise the bank’s pay- off in the event of liquidation associated to asset deterioration, jeopardiz- ing incentives. This paper shows that a microprudential regulatory regime that disregards the equilibrium effect of macro variables asset prices on micro behavior effort, performs poorly as low fundamental exogenous risk reduces bank’s effort and induces high endogenous deterioration risk. This analysis calls for a macroprudential regulatory regime in which the equilibrium feedback effect is fully taken into account by the author- ity in designing incentive compatible capital requirements, providing a theoretical foundation to the countercyclical buffer of Basel III.

Item Type: MPRA Paper -

Original Title: Incentives through the cycle: microfounded macroprudential regulation-

Language: English-

Keywords: Macroprudential regulation, financial stability, capital requirement.-

Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D86 - Economics of Contract: TheoryG - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and RegulationE - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy-

Autor: di Iasio, Giovanni


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