Essays on Bank Capital and Home Production

Chapters 1 and 2 are focused on capital and regulation in the banking system. The financial crisis of the late 2000’s demonstrated the need for a "macro" perspective of financial regulation. Systemic issues in the banking sector contributed to the resulting severe recession. This illustrated the need to think about regulation at the system level as opposed to the individual firm level. In other words, a "macroprudential" approach as opposed to a "microprudential" approach. The result has been a renewed interest from both regulators and researchers in the aggregate effects of financial regulation. This is especially true of bank capital regulation, a

primary component of the financial regulatory architecture. There are a number of variants and different thresholds that must be satisfied. However, generally, capital requirements are simply restrictions on the proportion of debt banks can use to finance themselves. Funding with more capital as opposed to debt acts as a buffer against earnings shocks. It also forces banks to have more "skin in the game", potentially reducing moral hazard problems due to deposit insurance. At the aggregate level, well-capitalized banks are better able to withstand economic downturns. This reduces the chances of cascading bank defaults or the failure of systemically important banks, events that can turn a recession into a financial crisis. A challenge with taking a "macroprudential" approach is the observed variation in levels of bank regulatory capital. This variation exists both across banks and within individual banks and over time. A proportion of banks have capital ratios that are typically near the regulatory constraint, while capital levels at many banks put them significantly away from these constraints. Additionally, bank’s capital ratios do not stay constant over time. In fact, for some banks, it can vary significantly, even from one quarter to the next. This is especially true in uncertain times, when returns and thus the level of bank equity capital are volatile, such as in recessions. This type of variation calls into question the role that capital regulation is playing in the determination bank capital ratios. Are bank’s significantly away from the regulatory capital constraint being impacted by it? How can we evaluate the impacts of regulatory policy in the presence of such heterogeneity? In these two chapters, I attempt to make progress on

addressing questions such as these. In Chapter 1, my objective is twofold. First, I attempt to document key patterns in observed regulatory capital ratios, as this is a necessary first step in attempting to understanding the implications of such variation. The regulatory measure I focus on is the total-risk based capital ratio (RBCR), a constraint on how much debt financing a bank can use relative to how much

risk it exposes itself to in its asset portfolio. This description implies two components of this statistics, a financing component and a portfolio component; and so, along with documenting key patterns in the RBCR itself, I do the same with each of these underlying parts as well. Second,

I try to provide some way of interpreting these cross-sectional and time series differences in regluatory capital by mapping to a measure of bank risk exposure, which is the ultimate concern of a regulator. This exercise shows that the "riskiness" of a given capital ratio is dependent on

both macro and bank-specific factors, specifically interest rates and cost efficiency, and that by accounting for these factors, a useful comparison of different levels of regulatory capital, across banks and over time, can be generated.

In Chapter 2, I turn my attention to the regulation itself, and ask: how does the banking industry respond to changes in capital regulation, and what does this imply about how the

burden of changing regulation is distributed between borrowers, savers, and banks? I consider this question in the context of a dynamic banking industry equilibrium framework. Heterogeneity, endogenous interest rates, and entry and exit allow for within-industry reallocation

in the provision of banking services. The extent of this reallocation determines how much of the cost of the regulation is paid by bank customers. In a quantitative exercise, the model is calibrated to features of the US banking industry, and I decompose changes in surplus for

banking market participants associated with a counterfactual tightening of capital requirements into the component driven by restricting bank behavior, and the component driven by the associated equilibrium reallocation in the provision bank services and endogenous industry changes that occur over the longer-run as a result of these restrictions. Chapter 3, a joint work with Nick Pretnar, is focused on how the concept of home production and more expansive notions about how households use their time can help us understand several long-term macroeconomic trends, primarily the shift from a goods-oriented to a services oriented economy in the United States. We construct a general equilibrium model with home

production where consumers choose how to spend their off-market time using market consumption purchases. The time-intensities and productivities of different home production

activities determine the degree to which variation in income and relative market prices affects both the composition of expenditure and market-labor hours per worker. For the United States, substitution effects due to relative price changes dominate income effects from wage growth

in contributing to the rise in the services share and the fall in hours per worker. The model generates a measure of welfare characterized by the relative value of in-home activities for households at different wage thresholds. When considering how welfare has changed for consumers of different incomes, we find that the variance of the cross-sectional distribution has risen since the 1980s, though to a lesser extent than implied by the evolution of the income

and wealth distributions. This is because improvements to technologies and the quality of the consumption stock have increased consumer welfare beyond what can easily be measured through expenditure or income.