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The Basel Accords promote the adoption of capital adequacy requirements to increase the banking sector's stability. Unfortunately, this type of regulation can hamper economic growth by shifting banks' portfolios from more productive, risky investment projects toward less productive but safer projects. This paper introduces banking regulation in an overlapping-generations model and studies how it affects economic growth, banking sector stability, and welfare. In this model, a banking crisis is initiated by an aggregated shock (in the risky sector) in a banking system with implicit bailout, and banking regulation is modeled as a constraint on the maximal share of banks' portfolios that can be allocated to risky assets.
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