Jointly optimal regulation of bank capital and maturity structure

Banks create excessive systemic risk through leverage and maturity mismatch, as financial constraints introduce welfare-reducing pecuniary externalities. Macroprudential regulators can achieve efficiency with simple linear constraints on banks' balance sheets, which require less information than Pigouvian taxes. These can be implemented using the Liquidity Coverage and Net Stable Funding ratios of Basel III. When bank failures are socially costly, microprudential regulation of leverage is also required. Optimally, macroprudential policy reacts to changes in systematic risk and credit conditions over the business cycle, while microprudential policy reacts to both systematic and idiosyncratic risk.