Does Bank Capital Matter for the Transmission of Monetary Policy?

Traditional monetary theory has largely ignored the role of bank equity. Bank-centred accounts of how monetary policy affects the real economy usually focus on the role of reserves and reserve requirements in determining the volume of demand deposits and, in the case of the bank lending channel, bank loans. As Benjamin Friedman (1991) observed, “Traditionally, most economists have regarded the fact that banks hold capital as at best a macroeconomic irrelevance and at worst a pedagogical inconvenience.” This stands in stark contrast with the importance attached to capital adequacy in the regulation of banks, especially since the adoption of the Basel Accord in 1988, which established risk-based capital requirements in the Group-of-Ten countries. The implementation of these regulations, along with other factors, has often been blamed for a perceived credit crunch in the United Sates immediately prior to and during the 1990–91 recession, Does Bank Capital Matter for the Transmission of Monetary Policy?