Caterina Mendicino, Kalin Nikolov, Juan Rubio-Ramirez, Javier Suarez, Dominik Supera, 24 February 2021

Well-capitalised banks make the financial system more resilient to episodes such as the COVID-19 crisis. This column assesses how much capital would be optimal for banks to hold, taking into consideration the risk of banking crises driven by borrower defaults. It finds that capital requirements of around 15% provide the optimal trade-off between lowering the frequency of banking crises caused by borrower defaults and maintaining the availability of credit in normal times. While the exact figure depends on a number of assumptions, it is higher than both the Basel III minimum and the optimum implied by macroeconomic frameworks that underestimate or neglect the impact of borrower default on bank solvency.

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