Capital and Resolution Policies : The US Interbank Market

We develop an empirically-based simulation study to test policies designed to control systemic risk. We consider preventive policies targeting capital requirements and mitigation policies targeting default resolution. We find that capital buffers reduce both defaults and losses. The loss reduction benefit resulting from capital buffers increases as the magnitude of adverse shocks becomes higher. We test a simple branch breakup resolution strategy which reduces the loss borne by the Federal Deposit Insurance Corporation (FDIC). The mitigation effect becomes higher as the fraction of assets resolved through auctions and auction competitiveness increases