Working papers

Exploiting the Safety Net: Optimal Bank Contracting Under Risk-Weighted Capital Requirements
the paper previously circulated as "Banks and Non-Banks: Competitors in Loan Origination, Partners in Regulatory Arbitrage"

Abstract: This paper develops a theory of optimal bank contracting under deposit insurance and risk-weighted capital requirements. Capital requirements are computed exposure by exposure, while the deposit guarantee covers the bank's net shortfall across the entire balance sheet. This regulatory asymmetry creates scope for financial contracts to increase the implicit government subsidy: by structuring the payoff of a specific loan portfolio to concentrate losses in states where the rest of the balance sheet also performs poorly, a bank can shift expected losses onto the deposit insurer without changing the risk weight of any individual asset. The analysis delivers two results that challenge the conventional interpretation of credit risk transfer. First, contracts that appear to transfer risk outside the banking sector need not reduce the implicit subsidy and can increase it, because the change in the joint distribution of cashflows across the balance sheet is invisible to exposure-based regulation. Second, the optimal contract can increase credit supply, but this expansion reflects enhanced rent extraction from the deposit insurance rather than an improvement in the social value of lending.
Related policy discussion (with Frederic Malherbe) on the growth of private markets in the UK following reforms introduced after 2008, opened by the Financial Services Regulation Committee (UK Parliament link)
Non-technical summary (UCL Econ Brief)

Cournot Competition in the Loan Market: Microfoundations and Limitations (submitted)

Abstract: When firms choose capacity and then compete à la Bertrand, the equilibrium corresponds to the Cournot outcome (Kreps and Scheinkman, 1983). In banking, regulatory capital requirements constrain a bank’s lending capacity, making capital choices analogous to capacity choices. This paper establishes the conditions under which the Bertrand-Cournot equivalence extends to banks with risky loans and asymmetric information. It shows that when competition remains capacity-driven, the equivalence holds, while when competition becomes information-driven, it breaks down. The paper also shows that under some conditions, competition remains capacity-driven under moral hazard and adverse selection, whereas it is information-driven under screening and relationship banking. These microfoundations clarify when Cournot competition is a valid and tractable modeling choice for the banking sector, and when it is not.

Publications

Bank Capital Requirements and Bank Lending: From Theory to Empirics to Policy (with Saleem Bahaj and Frederic Malherbe) 2026. Research Handbook of Macroprudential Regulation. (also CEPR DP19942)

Abstract: Macroprudential regulation is often viewed as a trade-off between banking system stability and aggregate credit supply. In this paper, we provide a comprehensive analysis of how changes in capital requirements affect bank lending. We use a theoretical framework to assess and nuance the trade-off. We show that imperfect competition, general equilibrium effects, and asset heterogeneity among banks result in lending responses that are complex and difficult to estimate. Armed with these theoretical insights, we assess existing strategies in the empirical literature and provide guidance for future research.