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The impact of imposing capital requirements on systemic risk
Affiliation:1. De Nederlandsche Bank, P.O. Box 98, 1000AB Amsterdam, The Netherlands;2. Erasmus University Rotterdam, P.O. Box 1738, 3000DR Rotterdam, The Netherlands
Abstract:This paper examines the impact of imposing capital requirements on systemic risk. We use a static model on financial institutions’ risk-taking behavior to quantify the systemic risk in the cross-sectional dimension in both regulated and unregulated systems. Although imposing a capital requirement can lower individual risk, it simultaneously enhances systemic linkage within the system. By using a proper systemic risk measure combining both individual risk and systemic linkage, we show that systemic risk in a regulated system can be higher than that in an unregulated system. In addition, we analyze a sufficient condition under which the systemic risk in a regulated system is always lower.
Keywords:Systemic risk  Capital requirement  macro-prudential regulation
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