Liquidity and Capital Requirements and the Probability of Bank Failure

Philipp Johann König
Using the model of Rochet and Vives (2004), this note shows that a prudential regulator 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 beyond the commonly envoked reasoning that they are to be used to control the riskiness of banks’ asset portfolios.
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