SFB 649 Discussion Paper 2010-027 Liquidity and Capital Requirements and the Probability of Bank Failure

Using the model of Rochet and Vives (2004), this note shows that a prudential reg-ulator can in general not mitigate a bank’s failure risk solely by means of liquidity requirements. However, their effectiveness can be restored if, in addition, minimum capital requirements are met. This provides a rationale for capital requirements be-yond the commonly envoked reasoning that they are to be used to control the riski-ness of banks ’ asset portfolios. JEL classification: G21, G2