Capital regulation Capital regulation – in particular, the imposition of minimum capital requirements – increases capital and thereby improves the ability of regulated financial institutions to absorb losses and maintain lending after a bubble has burst. More capital reduces the probability of institutions’ failure, with the added benefit of reducing the chance of funding runs due to loss of confidence.
But because higher required capital also generally increases the cost of funding assets – by increasing the role of capital in the funding mix – it also raises the possibility of reducing the supply of credit from regulated institutions, making credit more expensive. Thus, higher capital requirements, to some degree, also lean against excessive credit growth that can fuel asset bubbles.