The Political Economy of Prudential Regulation
Job Market Paper
This paper studies the equilibrium level of prudential regulation in a setting in which pecuniary externalities lead to overborrowing. A debt limit is implemented by a politician appointed through majoritarian elections. As voting allows borrowers to internalize the externality, the regulation restores constrained efficiency whenever the politician can commit to enforce it universally. Under selective enforcement, captured regulator may exempt politically connected borrowers from regulation. Depending on the electoral power of the connected, the outcome may be an either too lax or too strict policy. The analysis deepens the understanding of the role of political economy factors in affecting equilibrium regulation. Additional results highlight the impact of income inequality on strictness of the policy.
Funding Shocks and Credit Quality
joint with Enrico Perotti
Some credit booms, though by no means all, result in financial crises. While risk-taking incentives seem a plausible cause, most market participants do not appear to anticipate increasing risk. We show how credit expansions driven by credit supply shocks may be misunderstood as productivity driven, due to the opacity of bank balance sheets. Large funding shocks may induce some intermediaries to scale up speculative lending, distorting price signals. Most banks and firms may be led to misjudge profitability, reinforcing the expansion. Similarly, at times of low saving supply credit may be inefficiently low, and speculative assets underpriced.
On the Interaction Between Different Bank Liquidity Requirements
joint with Markus Behn and Renzo Corrias
The post-crisis regulatory framework introduced multiple requirements on banks’ capital and liquidity positions, sparking a discussion among policymakers and academics on how the various requirements interact with one another. This article contributes to the discussion on the interaction of different regulatory metrics by empirically examining the interaction between the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) for banks in the euro area. The findings suggest that the two liquidity requirements are complementary and constrain different types of banks in different ways, similarly to the risk-based and leverage ratio requirements in the capital framework. This dispels claims that the LCR and the NSFR are redundant and underlines the need for a faithful and consistent implementation of both measures (and the entire Basel III package more broadly) across all major jurisdictions, to maintain a level playing field at the global level and to ensure that the post-crisis regulatory framework delivers on its objectives.