## Cyclical Implications of Changing Bank Capital Requirements in a Macroeconomic Framework

_IMF Working Papers, August 1, 2005_

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## Bibliographic details
- Authors: Eduardo J Ganapolsky, Mario Catalan
- Published: August 1, 2005
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451861877.001

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### Abstract and Framework
- Presents an intertemporal general equilibrium framework that accounts for the effects of capital requirement policies on households' saving decisions and, through this channel, on bank loans and output.
- Evaluates optimal responses to two shock types:
  - Loan supply shocks (reduced loan supply).
  - Productivity (loan demand) shocks (reduced productivity / loan demand).

### Key Findings
- Common view summarized: "Bank capital requirements should be loosened during recessions and tightened during expansions to avoid excessive credit and output swings."
- Critique of common view: That view is based on a partial analysis that ignores effects on household saving decisions and subsequent impacts on loans and output.
- When loan supply is reduced:
  - Increasing the capital requirement allows a faster recovery of households' savings, loans, and output than a flat capital requirement policy.
- When productivity (loan demand) is reduced:
  - Lowering the capital requirement facilitates households' dissaving and amplifies the output decline, but enhances welfare.
- If productivity reductions are anticipated (rather than unanticipated) by regulators:
  - Lowering the capital requirement preemptively enhances welfare through greater intertemporal smoothing of households' consumption and deposit holdings.

### Policy Implications and Recommendations
- Policy prescriptions that ignore household saving responses may be misleading.
- Optimal capital requirement responses depend on the shock type:
  - For loan supply reductions, consider increasing capital requirements to speed recovery of savings, loans, and output.
  - For productivity/loan demand reductions, lowering capital requirements can improve welfare despite amplifying output declines by facilitating household dissaving.
  - If productivity reductions are anticipated, preemptive lowering of capital requirements can enhance welfare via better intertemporal smoothing of consumption and deposits.
- Regulatory timing and information (anticipated vs. unanticipated shocks) materially affect welfare outcomes and should inform capital requirement policy design.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/cyclical-implications-of-changing-bank-capital-requirements-in-a-macroeconomic-framework-18486_