Essays on bank capital, macroeconomic activity and financial deepening
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This dissertation consists of three essays on banking. The first two chapters analyze, theoretically and empirically, the relationship between bank capital and macroeconomic activity. The third chapter addresses a policy question about financial deepening in some emerging market economies. The first chapter develops a dynamic stochastic general equilibrium model to examine the impact of macroprudential regulation on the bank's financial decisions and the implications for the real sector. It explicitly incorporates costs and benefits of capital requirements. We model an occasionally binding capital constraint and approximate it using an asymmetric nonlinear penalty function. It is seen that higher capital requirements can dampen business cycle fluctuations and stronger regulation can induce banks to hold buffers and hence mitigate an economic downturn. We also see that higher capital requirements can enhance the welfare of the economy as a whole. Lastly, we find that switching to a counter-cyclical capital requirement regime can help moderate business cycle fluctuations and raise welfare. The second chapter empirically evaluates the impact of bank capital on lending patterns using an innovative instrumenting strategy. We construct an unbalanced quarterly panel of around nine thousand commercial banks over sixty quarters, from 1996 to 2010. Using different measures of capital, we find a moderate relationship between bank equity and lending. The relationship is also found to differ by size. The bigger banks have a greater responsiveness of lending to capital than smaller ones. The third chapter evaluates financial deepening in the West African Economic and Monetary Union (WAEMU) and compares their performance with other top performers in Africa. First, we use an unbalanced panel of 16 countries and 158 banks and document some key areas that need immediate policy attention. Next, we use the financial possibility frontier methodology to benchmark the performance of some important economies in our sample, with respect to each other and their estimated potential. We find that the WAEMU countries perform poorly compared to the control group and their own estimated potential. We make policy recommendations to solve this problem and increase financial depth.