DP3721 Capital Requirements, Market Power and Risk-Taking in Banking
|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.