Minimum capital requirements increase systemic risk

Basel II minimum capital regulations may see lower risk holdings by individual financial institutions but see increased systemic risk, argues Chen Zhou in a recent Netherlands Bank working paper.

Chen shows that minimum capital requirements cause higher correlation between bank portfolios than would occur without regulation. "Intuitively, when imposing a capital requirement, the regulation plays a dominate role in guiding the optimal strategy. It overrides the impact of the individual risk

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