Bank Capital Regulation in a Zero Interest Environment

Abstract How does the zero lower bound on deposit rates (ZLB) affect how banks respond to capital regulation? I study this question in a model in which households value the liquidity services of deposits yet do not accept negative deposit rates. When deposit rates are constrained by the ZLB, tight capital requirements disproportionately hurt franchise values and are therefore less effective in curbing excessive risk taking. The model delivers a novel rationale for “interest-dependent” capital regulation that is optimally laxer when the ZLB binds and tighter when the ZLB is slack but may bind in the future.