Macroeconomic Shocks and Banking Regulation

macroeconomic shocks and banking regulation
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  Macroeconomic Shocks and Banking Regulation ∗ Mathias Dewatripont † Jean Tirole  ‡ September 7 ,  202 Abstract The recent crisis has brought to the !ore the c clical properties o! banking regu#lation$ %ounterc clical bu&ers and enhanced capital re'uirements meant to stabili(ebanks) balance sheets across the c cle are not costless, and a delicate balance needsto be reached between pro*iding incenti*es to generate *alue and discouraging e+#cessi*e risk#taking$The paper de*elops a model in which, in contrast with Modigliani#Miller, out#side e'uit and capital re'uirements matter$ t anal ses banking regulation inthe presence o! macroeconomic shocks and studies the desirabilit o! sel!#insurancemechanisms such as counterc clical capital bu&ers or d namic pro*isioning, as wellas -macro#hedges. such as %o%os and capital insurance$ Keywords:  Banking regulation, macroeconomic shocks, counterc clical capitalre'uirements$ JEL numbers:  /2, 12, 12$ ∗ This paper is an e+panded *ersion o! a presentation made b Mathias Dewatripont at the JM%B#3B#4niBern 20 con!erence at the Stud %enter 1er(ensee$ The authors are grate!ul to 5ans 1ersbach, theeditor and an anon mous re!eree !or help!ul comments$ The research leading to these results has recei*ed!unding !rom the /uropean Research %ouncil under the /uropean %ommunit )s Se*enth Framework6rogramme F6782007#209 1rant :greement no$ 2;<;2<$ † Ban'ue 3ationale de Belgi'ue$ 4ni*ersit= >ibre de Bru+elles /%:R/S and Sol*a Brussels School9$mathias$dewatripont?nbb$be @ mdewat?ulb$ac$be ‡ Toulouse School o! /conomics$ Aean$tirole?tse#!r$eu$   1 Introduction and motivation t is commonl agreed that microprudential banking regulations, Basel  and e*en moreso9 Basel , ampli! the impact o! the economic c cle on balance sheets and make banksmore *ulnerable to downturns$ To reduce this proc clicalit and to strengthen bankingstabilit , Basel  re'uires more capital and introduces counterc clical capital bu&ers$More generall , banking recapitali(ation has been high on polic makers) agenda despiteconcerns about dele*eraging and a potential credit crunch$ Moreo*er, man scholars, mostnotabl :dmati et al$ 2009, ha*e called !or much higher capital ratios than re'uirede*en under Basel , arguing that e'uit is not reall costl $:dmati et al)s theoretical point goes as !ollows e+isting models o! capital ade'uac in banking and corporate Cnance emphasi(e the need !or inside e'uit , i$e$ e'uit broughtb those, such as managers and large monitors *enture capitalists, block shareholders9,who can destro *alue and there!ore must be gi*en skin in the game$ But the legal andregulator concepts o! e'uit include outside e'uit , i$e$, e'uit held b passi*e share#holders who do not necessaril impact the corporate strateg $ :dmati et al)s reasoningis that, while inside e'uit is, as is widel acknowledged, costl 8 scarce, outside e'uit is not$ The cushion created b e'uit could be rein!orced b adding, sa , mone market!unds as an e+tra line o! de!ense to protect depositors$ 6ut di&erentl , while inside e'uit is rele*ant, outside e'uit and debt obe the assumptions o! Modigliani#Miller <9and so the social cost o! outside e'uit e'uals that o! debt$ mplications o! this lineo! reasoning !or capital ade'uac re'uirements are then unclear@ indeed, e+isting capi#tal ade'uac re'uirements and current attempts at rein!orcing bank capital cannot berationali(ed without addressing the *er rele*ance o! outside e'uit $Ehile its theoretical, uncalibrated nature precludes an Audgment about the desirabil#it o! Basel  re!orms, this paper argues against the *iew that the social cost o! substan#tiall heightened capital re'uirements are negligible$ t e+tends Dewatripont#Tirole <<;a, b9)s theor o! outside capital structure to allow !or the presence o! macroeconomicshocks$ t in*estigates the conse'uences o! such shocks !or e+isting regulation and re!ormproposals$The theor is based on the idea that managerial incenti*es depend on how broadercorporate choices are a&ected b per!ormance$ 6olicies that *alidate managerial choices!ollowing good per!ormance, and constrain8downsi(e8li'uidate a!ter a bad one ser*e asa power!ul incenti*e !or managerial compliance$ Ehile !orward#looking proCt ma+imi(a#tion implies that b gones are b gones and poor good9 per!ormance remains unpunishedunrewarded9, shareholder control in good times and a shi!t in control !rom shareholders2  to debtholders a!ter poor per!ormance b contrast rewards penali(es9 managers !or theirgood poor9 per!ormance$ Thus the paradigm belongs to the !amil o! models that *iewdebt as a disciplining de*ice Townsend <7<, 1ale#5ellwig <, :ghion#Bolton <<2,5art#Moore <<;9@ like in this literature, debt can operate through downsi(ing or li'uida#tion a!ter low proCts$ The implications o! debt control are broader including all actionsthat are not aligned with managerial pre!erences9$ :nd especiall , the model predicts arole !or outside e'uit , unlike the rest o! the literature$The desirabilit o! toughening corporate policies a!ter poor per!ormance howe*er ap#plies onl to that part o! the per!ormance that is under managerial control$ From 5olm#strm <7<9)s insulation principle, the !ate o! economic agents should a priori not beconditioned on e*ents, such as macroeconomic shocks, that lie outside their control$ n#*estigating the conse'uences o! this basic principle leads to the !ollowing conclusions ã  The Basel  and  polic o! ignoring macroeconomic shocks in the determination o! capital ade'uac re'uirements leads to too much inter*ention in recessions and toomuch lenienc in booms the regulation rewards the Gluck dollarG9$ ã  Forbearance, a commonl adopted super*isor polic o! de !acto lowering capitalade'uac re'uirements during a recession in conHict with Basel rules9, does a bet#ter Aob at insulating managers !rom macroeconomic shocks@ but it creates si(ableincenti*es !or gambling b then#undercapitali(ed banks$ ã  Iptimal regulation re'uires that macroeconomic shocks be automaticall neutral#i(ed, so as to keep the incenti*es o! the in*estor in control unchanged$ This neutral#i(ation can take the !orm o! d namic pro*isioning or a Basel 9 counterc clicalcapital bu&er pro*ided sel!#insurance is !easible@ i! it is not, macro#hedging such ascapital insurance or %o%os can achie*e this goal$ ã  1eneral e'uilibrium properties o! these alternati*e instruments are an importanttopic !or research$The paper is organi(ed as !ollows Section 2 sets up the basic model$ Section introduces macroeconomic shocks$ Section ; brieH discusses general e'uilibrium aspectsand section  concludes$Finall , the e+isting literature on macroprudential regulation has a rather di&erent!ocus$ Iur paper !ocuses on how prudential regulation should deal with macro shocks,not on other reasons that ha*e been in*oked as Ge+ternalit #basedG rationales !or macro#prudential regulation, such as interconnectedness e$g$, :llen#1ale 2000, %aballero#Simsek  200, Rochet#Tirole <<9, Cre sales e$g$, >oren(oni 2009, sur*eillance o! asset bubbles,or widespread maturit mismatches e$g$, Farhi#Tirole 2029$ 2 A simple setting n the spirit o! the branch o! the securit design literature initiated b :ghion and Bolton<<29, who argued that securities are characteri(ed not onl b income rights but alsob control rights, we anal (ed in Dewatripont and Tirole <<;a9 a managerial moralha(ard problem in which it is optimal to discipline the manager at least in part throughper!ormance#contingent corporate choices$Ee argued that, i! the corporate actions meant to discipline the manager are not con#tractible, and i!, as is generall the case, optimal corporate choices are time#inconsistent,in*estors in control o! corporate choices must !ace an incenti*e that di&ers !rom Crm#*aluema+imi(ation, in order to be induced to take the e+#ante optimal action$ This -doublemoral ha(ard problem. in turn calls !or the presence o! at least a second group o! outsidein*estors who recei*e the remainder o! the re*enue o! the Crm$ This second group o! in*estors is similar to the Gbudget breakerG introduced b 5olmstrm <29 to addressmoral ha(ard in teams$Suppose that the action the manager pre!ers call it  C  !or GcontinuationG9 is riskierthan the action she likes less call it  L  !or Gli'uidationG9@ the eKcient pro*ision o! man#agerial incenti*es calls !or allocating control to in*estors with a conca*e, i$e$, Gdebt#likeG,return a!ter bad per!ormance, and a con*e+, i$e$, Ge'uit #likeG, return a!ter good per!or#mance$ This suggests that the second#best optimum can be implemented with standarddebt and outside9 e'uit , with contingent control e'uit control a!ter good per!ormance,and debt control a!ter bad per!ormance$ The model thus predicts securities which consisto! realistic bundles o! control and income rights$This section describes the obAecti*e !unctions, the timing, the second#best optimalper!ormance#contingent action choice, and Cnall the latter)s implementation through anappropriate debt#e'uit ratio$ 2.1 Timing :s discussed abo*e, the model in*ol*es both managerial and corporate choices$ : bankingmanager8entrepreneur has no Cnancial resources to co*er an in*estment cost, and turnsto in*estors !or Cnancing$ The capital structure# that is, the allocation among in*estors o! contingent cash#How and control rights# is designed at this Cnancing stage$ The manager;


Jul 23, 2017
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