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Economic and Regulatory Capital in Banking: What Is the Difference?

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Author Info
Abel Elizalde (CEMFI and UPNA)
Rafael Repullo (CEMFI and CEPR)

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Abstract

We analyze the determinants of regulatory capital (the minimum required by regulation), economic capital (that chosen by shareholders without regulation), and actual capital (that chosen with regulation) in a dynamic model of a bank with a loan-portfolio return described by the single-risk-factor model of Basel II. We show that variables that only affect economic capital, such as the intermediation margin and the cost of capital, can account for large deviations from regulatory capital. Actual capital is closer to regulatory capital, but the threat of closing undercapitalized banks generates significant capital buffers. Market discipline, proxied by the coverage of deposit insurance, increases economic and actual capital, although the effects are small.

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Publisher Info
Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 3 (2007)
Issue (Month): 3 (September)
Pages: 87-117
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Handle: RePEc:ijc:ijcjou:y:2007:q:3:a:3

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Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Steven A. Zimmer & Robert N. McCauley, 1990. "Bank cost of capital and international competition," Quarterly Review, Federal Reserve Bank of New York, issue Win, pages 33-59.
  2. Estrella, Arturo, 2004. "The cyclical behavior of optimal bank capital," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1469-1498, June. [Downloadable!] (restricted)
  3. Jackson, Patricia & Perraudin, William & Saporta, Victoria, 2002. "Regulatory and "economic" solvency standards for internationally active banks," Journal of Banking & Finance, Elsevier, vol. 26(5), pages 953-976, May. [Downloadable!] (restricted)
  4. David Jones & John Mingo, 1998. "Industry practices in credit risk modeling and internal capital allocations: implications for a models-based regulatory capital standard," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 53-60. [Downloadable!]
  5. Repullo, Rafael & Suarez, Javier, 2004. "Loan pricing under Basel capital requirements," Journal of Financial Intermediation, Elsevier, vol. 13(4), pages 496-521, October. [Downloadable!] (restricted)
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  6. Aggarwal, Raj & Jacques, Kevin T., 2001. "The impact of FDICIA and prompt corrective action on bank capital and risk: Estimates using a simultaneous equations model," Journal of Banking & Finance, Elsevier, vol. 25(6), pages 1139-1160, June. [Downloadable!] (restricted)
  7. Calem, Paul & Rob, Rafael, 1999. "The Impact of Capital-Based Regulation on Bank Risk-Taking," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 317-352, October. [Downloadable!] (restricted)
  8. Michael B. Gordy, 2002. "A risk-factor model foundation for ratings-based bank capital rules," Finance and Economics Discussion Series 2002-55, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  9. Repullo, Rafael, 2004. "Capital requirements, market power, and risk-taking in banking," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 156-182, April. [Downloadable!] (restricted)
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  10. Mark Carey, 2001. "Dimensions of Credit Risk and Their Relationship to Economic Capital Requirements," NBER Chapters, in: Prudential Supervision: What Works and What Doesn't, pages 197-232 National Bureau of Economic Research, Inc. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Xavier Freixas & Bruno Maria Parigi, 2007. "Banking Regulation and Prompt Corrective Action," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
  2. Repullo, Rafael & Suarez, Javier, 2008. "The Procyclical Effects of Basel II," CEPR Discussion Papers 6862, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  3. Martinez-Miera, David & Repullo, Rafael, 2008. "Does Competition Reduce the Risk of Bank Failure?," CEPR Discussion Papers 6669, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  4. Haibin Zhu, 2008. "Capital Regulation and Banks' Financial Decisions," International Journal of Central Banking, International Journal of Central Banking, vol. 4(1), pages 165-211, March. [Downloadable!]
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