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Crises and Capital Requirements in Banking

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  • Alan D. Morrison
  • Lucy White
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    Abstract

    We analyze a general equilibrium model in which there is both adverse selection of, and moral hazard by, banks. The regulator can screen banks prior to giving them a licence, audit them ex post to learn the success probability of their projects, and impose capital adequacy requirements. Capital requirements combat moral hazard when the regulator has a strong screening reputation, and they otherwise substitute for screening ability. Crises of confidence can occur only in the latter case, and contrary to conventional wisdom, the appropriate policy response may be to tighten capital requirements to improve the quality of surviving banks.

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/000282805775014254
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    Bibliographic Info

    Article provided by American Economic Association in its journal American Economic Review.

    Volume (Year): 95 (2005)
    Issue (Month): 5 (December)
    Pages: 1548-1572

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    Handle: RePEc:aea:aecrev:v:95:y:2005:i:5:p:1548-1572

    Note: DOI: 10.1257/000282805775014254
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    1. Morrison, Alan & White, Lucy, 2005. "Level Playing Fields in International Financial Regulation," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5247, C.E.P.R. Discussion Papers.
    2. Itay Goldstein & Ady Pauzner, 2005. "Demand-Deposit Contracts and the Probability of Bank Runs," Journal of Finance, American Finance Association, American Finance Association, vol. 60(3), pages 1293-1327, 06.
    3. Barth, James R. & Caprio Jr., Gerard & Levine, Ross, 2001. "Bank regulation and supervision : what works best?," Policy Research Working Paper Series 2725, The World Bank.
    4. Mathias Dewatripont & Jean Tirole, 1993. "Efficient governance structure: implications for banking regulation," ULB Institutional Repository 2013/9655, ULB -- Universite Libre de Bruxelles.
    5. Edward J. Kane, 1989. "How Incentive-Incompatible Deposit-Insurance Funds Fail," NBER Working Papers 2836, National Bureau of Economic Research, Inc.
    6. Bhattacharya, Sudipto, 1982. " Aspects of Monetary and Banking Theory and Moral Hazard," Journal of Finance, American Finance Association, American Finance Association, vol. 37(2), pages 371-84, May.
    7. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, American Finance Association, vol. 55(6), pages 2431-2465, December.
    8. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    9. Bengt Holmstrom & Jean Tirole, 1994. "Financial Intermediation, Loanable Funds and the Real Sector," Working papers 95-1, Massachusetts Institute of Technology (MIT), Department of Economics.
    10. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
    11. Morris, Stephen & Shin, Hyun Song, 1997. "Unique Equilibrium in a Model of Self-fulfilling Currency Attacks," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1687, C.E.P.R. Discussion Papers.
    12. Gary Gorton & Andrew Winton, 2002. "Financial Intermediation," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 02-28, Wharton School Center for Financial Institutions, University of Pennsylvania.
    13. Rochet, Jean-Charles, 1992. "Capital requirements and the behaviour of commercial banks," European Economic Review, Elsevier, vol. 36(5), pages 1137-1170, June.
    14. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, American Economic Association, vol. 90(1), pages 147-165, March.
    15. Barth, James R. & Caprio Jr, Gerard & Levine, Ross, 2001. "The regulation and supervision of banks around the world - a new database," Policy Research Working Paper Series 2588, The World Bank.
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