Discussion Paper Details

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Title: Capital Requirements, Market Power and Risk-Taking in Banking

Author(s): Rafael Repullo

Publication Date: January 2003

Keyword(s): bank regulation, capital requirements, deposit rate ceilings, franchise values, imperfect competition, moral hazard and risk-shifting

Programme Area(s): Financial Economics

Abstract: This Paper presents a dynamic model of imperfect competition in banking where banks can invest in a prudent or a gambling asset. We show that if intermediation margins are small, the banks? franchise values will be small, and in the absence of regulation only a gambling equilibrium will exist. In this case, either flat-rate capital requirements or binding deposit rate ceilings can ensure the existence of a prudent equilibrium, although both have a negative impact on deposit rates. Such impact does not obtain with either risk-based capital requirements or non-binding deposit rate ceilings, but only the former are always effective in controlling risk-shifting incentives.

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Bibliographic Reference

Repullo, R. 2003. 'Capital Requirements, Market Power and Risk-Taking in Banking'. London, Centre for Economic Policy Research.