Capital Adequacy Rules: Implications for Banks' Risk-Taking

It is argued that the liberalization of financial markets and the increasing mobility of customers have rendered national banking regulation increasingly ineffective and led to a process of deregulation. Capital adequacy rules are the central instrument for a starting process of reregulation and international harmonization of the regulation of banks. Their advantage consists in their simplicity. Their allocative consequences are less clear. For example, it is argued that the structure of the competitive environment is important in assessing the likely consequences of capital regulation. In perfectly competitive markets capital requirements tend to reduce management discretion and, therefore, reduce risk-taking. In imperfectly competitive markets capital requirements tend to reduce the intensity of competition. Nevertheless their overall consequences are ambiguous.