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Reserve Requirements and Financial Stability
This study assesses the effects of reserve requirements on the probability of bank failure and compares them to those of capital
requirements. While both requirements affect banks' balance sheets and lending rates similarly, their effects on financial
stability can differ markedly. When adjustment in deposit rates is constrained, the cost effect arising from higher reserve
requirements may incentivise banks to choose riskier assets rendering worse financial conditions. Borrowers' moral hazard
problem augments these adverse effects. They are mitigated when considering imperfectly correlated loan-default as higher
interest revenues from non-defaulting loans curb losses from defaulting loans.
Keywords:Reserve requirements, Liquidity regulation, Capital requirements, Bank failure, Default correlation
Forschungsbereich:Makroökonomie und öffentliche Finanzen
Sprache:Englisch