Bank capital requirements and the monetary transmission mechanism

This paper examines the fundamental effects of bank capital requirements on the loan transmission mechanism and the scale and mix of bank deposit liabilities and equity. We focus on the role of short- and long-run adjustments, in which the driving "fundamentals" for the banking sector are the risk-free interest rate determined by monetary policy makers, term-structure risk, the riskiness of non-bank debt, and the cost structure of banks. Within this framework, we show that risk-based capital standards change basic short- and long-run loan-market outcomes, relative to the outcomes under either non-risk-based capital standards or no capital requirements. Moreover, we show that non-risk-based standards primarily influence the structure of bank liabilities. (C) 2004 Elsevier Inc. All rights reserved.