PhD Lunch Seminars Amsterdam

Robin Döttling (University of Amsterdam)
Tuesday, 14 November 2017

How do near-zero interest rates affect bank competition, risk taking and financial regulation? I study these questions in a tractable dynamic general equilibrium model, in which forward-looking banks compete imperfectly for deposit funding, and deposit insurance may induce excessive risk taking. The zero lower bound (ZLB) distorts bank competition and boosts risk shifting incentives, particularly if rates are expected to remain near-zero for long. At the ZLB, capital regulation becomes a less effective tool to curb moral hazard. When banks cannot pass on the cost of capital to depositors, tight capital requirements erode franchise value, countervailing the usual “skin in the game” effect. Very low interest rates may therefore motivate weaker capital regulation, despite overall higher risk. Complementing existing regulation with policy tools that directly support the funding cost of banks may improve welfare.