Three essays on banking regulations

One of the main aims of the Basel Accords, issued by the Basel Committee on Banking Supervision (BCBS), is to strengthen the soundness and stability of the international banking system. The objective of this thesis is to evaluate the impact of the capital and liquidity requirements outlined in the various Basel Accords (i.e. Basel I, II, III and IV) on social welfare, probability of bank failure, credit supply, and financial stability (during business cycles). This thesis further tests a new tool, a systemic tax, proposed to be levied on global Systemically Important Banks (G-SIBs) to cover the expected costs of interventions (i.e. bailouts) in the case of default of those institutions. Firstly, I develop a static equilibrium model to investigate the impact of the aforementioned systemic tax on banks’ capital holdings, optimal capital requirements, and social welfare. This research contributes to the literature by evaluating the performance of the systemic tax and by estimating the optimal requirements for G-SIBs and non-G-SIBs. I find the tax would not only result in a safer banking system but also help to mitigate the pro-cyclical effects of the banking capital requirements introduced by Basel II. However, these merits would come at the cost of an increase in loan rates, which transfers the cost to firms (i.e. the borrowers). However, the tax is less effective in improving social welfare when the capital requirements are strengthened, i.e. under Basel III and Basel IV. Regarding welfare, Basel II is superior to the other regimes considered. Although Basel III and Basel IV results in a safer and more stable banking system, these improvements sacrifice social welfare. I also find that regulators should set higher capital requirements for G-SIBs, due to their systemic importance to the banking system, which is in line with the rules in Basel III and Basel IV. I also employ a static equilibrium model to compare banks’ endogenous capital and liquidity holdings under the various Accords, considering the implementation of liquidity requirements as introduced by Basel III. This research contributes to the literature by considering the business cycle effect when analysing banks’ endogenous choices of capital and liquidity holdings and when looking into the importance of liquidity requirements in this context. In this improved model, I consider the possibility of fire sales if banks have insufficient liquidity holdings to tackle (large and negative) deposit variations. I find that banks’ liquidity is countercyclical, while their capital buffer is pro-cyclical. The countercyclical liquidity holding behaviour causes a larger fire sale loss during economic expansions, which suggests that the liquidity requirements are important during these periods. I also find that Basel III and Basel IV reduces bank fragility at the expense of lower social welfare. Lastly, I employ a dynamic model in which an interbank market is established to help banks manage short-term idiosyncratic deposit variations, which leaves them in liquidity surplus or deficit. This research contributes to the literature by shedding new light on the impact of the interbank market on bank lending and social welfare, under different (capital and liquidity) requirement regimes and various governmental policies, such as central bank interventions to fully satisfy interbank needs. Another contribution of this research is that it provides a comparison of the aforementioned requirements from a macro-prudential perspective by considering the interbank market, which has been less analysed in existing studies. I find that bank lending would be reduced if the liquidity supply or demand is not fully satisfied by the interbank market. Thus, a central bank intervention to satisfy interbank needs would help to boost bank lending and thus social welfare. I then incorporate capital and liquidity requirements, represented by Basel III, into the model and find that in normal times combining the capital and liquidity requirements lowers social welfare by restricting bank lending and interbank market participation. However, during financial crises, the liquidity requirements outperform the capital requirements by stabilising bank lending. I also find that imposing Basel IV-style requirement, such as a higher capital requirement to mitigate counterparty credit risks, would improve social welfare, indicating that the forthcoming Basel IV would be on a right track in reducing bankruptcies and thus improving social welfare. In summary, my thesis provides a detailed evaluation (and comparison) of the Basel Accords, especially in terms of the impact of capital and liquidity requirements on financial stability and social welfare, and a novel assessment of a newly proposed systemic tax. This research, then, is important and of interest to policymakers and regulators