Determining Banking Economic Capital considering the role of the central bank Using a Dynamic Stochastic General Equilibrium (DSGE) Model

Document Type : Original Article

Authors

1 دانشجوی دکتری

2 allame

Abstract

Objective: Economic capital serves as a crucial tool for risk management and covering unexpected losses. The level of banking capital represents a balance between profitability and risk coverage capacity. The objective of this research is to determine banking economic capital (buffer surplus over Basel regulations) using the DSGE model and examine the impact of economic shocks on this capital.

Method: This research was conducted using a quantitative approach and DSGE modeling. The model includes five sectors (banks, households, firms, capital market, and central bank) and incorporates liquidity, productivity, and monetary policy shocks. The central bank follows a Taylor rule augmented with a financial stability objective (macroprudential policy). Economic welfare criteria were used to evaluate the optimal balance between profitability and financial stability. The model accounts for the specific characteristics of Iran's banking system, including limited bank exit mechanisms and central bank support for distressed banks.

Findings The results showed that the optimal capital level for banks was estimated at 12.9 percent in steady state, indicating the necessity of a buffer surplus over Basel III requirements. The model demonstrates that in the absence of effective exit mechanisms and with continuous central bank support, maintaining suboptimal banks imposes significant welfare costs through increased liquidity injection and inflation (estimated at 4-6 percentage points annually). Liquidity shocks have substantial impact on the banking sector dynamics and required capital.

Conclusion: Iranian banks need approximately 13 percent capital to maintain financial stability under current institutional arrangements, which is higher than Basel international standards.

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History

  • Receive Date: 02 August 2025
  • Revise Date: 16 December 2025
  • Accept Date: 10 June 2026

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