DP3721 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, risk-shifting
JEL(s):	D43, G21, G28
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=3721

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.