Capital requirements and growth in an open economy

This paper studies the effects of capital requirements, both independently and jointly with the degrees of financial development and financial openness, on economic growth. The first part illustrates how these effects operate in a simple two-period endogenous growth model with banking. The second part provides an empirical analysis based on panel data regressions for a sample of 107 advanced and developing economies. Sensitivity analysis, including with respect to potential causality and endogeneity issues, is also provided. The results show, in particular, that capital requirements can promote growth by mitigating the risk of financial crises, possibly by encouraging (in line with the skin in the game argument) prudent lending. However, financial development and financial openness tend to mitigate the growth benefits of these policies, because of increased scope for (domestic and cross-border) regulatory arbitrage and, in the case of financial openness, greater opportunities to borrow abroad.