A Static Capital Buffer is Hard To Beat

RePEc Short ID: pmi943
ORCID iD: 0000-0001-8309-509X

Canzoneri, Matthew B.; Diba, Behzad T.; Guerrieri, Luca; Mishin, Arsenii

doi:10.17016/FEDS.2026.042

Working Paper

A Static Capital Buffer is Hard To Beat

Abstract: In a model with endogenous risk-taking, deposit insurance and limited liability may lead banks to make risky loans that are socially inefficient. Capital requirements can prevent excessive risk-taking at the cost of reducing liquidity-producing bank deposits. A policy that sets capital requirements just high enough to prevent excessive risktaking will move capital requirements pro-, counter-, or a-cyclically depending on the shock source. However, such a policy requires full knowledge of all the shocks hitting the economy and is not implementable. Simple rules that respond to cyclical conditions—in line with Basel III guidance—perform poorly, whereas a small static capital buffer can do much better.

JEL Classification: C54; E13; G21;

https://doi.org/10.17016/FEDS.2026.042