Microprudential bank capital regulation in a complex system.

This paper analyzes the efficacy of microprudential (bank-level) capital requirements in mitigating failure cascades in a network of interconnected banks. In simulation exercises, microprudential capital requirements redistribute the troubled assets of undercapitalized banks more broadly within the network, reducing the immediate likelihood of individual bank failures but increasing the likelihood of large failure cascades. This effect is strongest for simulation parameters that mimic economic downturns.