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Economic And Regulatory Capital. What Is The Difference?

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Author Info
Abel Elizalde ()
Rafael Repullo () (CEMFI, Centro de Estudios Monetarios y Financieros)

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Abstract

This paper analyzes the determinants of regulatory capital (the minimum required by regulation) and economic capital (the capital that shareholders would choose in absence of regulation) in the context of the single risk factor model that underlies the New Basel Capital Accord (Basel II). The results show that economic and regulatory capital do not depend on the same set of variables and values, they are both increasing in the loans' probability of default and loss given default, but variables that affect economic but not regulatory capital, such as the intermediation margin and the cost of capital, can move them significantly apart. The results also show that market discipline, proxied by the coverage of deposit insurance, increases economic capital, although the effect is generally small.

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Paper provided by CEMFI in its series Working Papers with number wp2004_0422.

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Date of creation: Dec 2004
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Handle: RePEc:cmf:wpaper:wp2004_0422

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Related research
Keywords: Bank regulation; capital requirements; market discipline; credit risk; Basel II.;

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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

This paper has been announced in the following NEP Reports:

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. Kai-Uwe Kühn & Matilde Machado, 2004. "Bilateral Market Power And Vertical Integration In The Spanish Electricity Spot Market," Working Papers wp2004_0414, CEMFI. [Downloadable!]
    Other versions:
  2. Guillermo Caruana & Marco Celentani, 2001. "Career Concerns And Contingent Compensation," Economics Working Papers we014811, Universidad Carlos III, Departamento de Economía. [Downloadable!]
  3. Samuel Bentolila & Juan F. Jimeno, 2003. "Spanish Unemployment: The End of the Wild Ride?," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  4. Claudio Michelacci, 2003. "Low Returns in R&D Due to the Lack of Entrepreneurial Skills," Economic Journal, Royal Economic Society, vol. 113(484), pages 207-225, January. [Downloadable!] (restricted)
  5. Gabriele Fiorentini & Enrique Sentana & Neil Shephard, 2004. "Likelihood-based estimation of latent generalised ARCH structures," OFRC Working Papers Series 2004fe02, Oxford Financial Research Centre. [Downloadable!]
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  6. Javier Alvarez & Manuel Arellano, 2004. "Robust Likelihood Estimation Of Dynamic Panel Data Models," Working Papers wp2004_0421, CEMFI. [Downloadable!]
  7. Diaz, Antonia & Pijoan-Mas, Josep & Rios-Rull, Jose-Victor, 2003. "Precautionary savings and wealth distribution under habit formation preferences," Journal of Monetary Economics, Elsevier, vol. 50(6), pages 1257-1291, September. [Downloadable!] (restricted)
  8. Guillermo Caruana & Liran Einav, 2008. "A Theory of Endogenous Commitment," Review of Economic Studies, Blackwell Publishing, vol. 75(1), pages 99-116, 01. [Downloadable!] (restricted)
  9. Gerard Llobet & Meritxell Albertí & Ángel León, 2003. "Evaluation Of A Taxi Sector Reform: A Real Options Approach," Working Papers wp2003_0312, CEMFI. [Downloadable!]
  10. Almazan, Andres & Suarez, Javier & Titman, Sheridan, 2004. "Stakeholders, Transparency and Capital Structure," CEPR Discussion Papers 4181, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  11. Enrique Sentana & Giorgio Calzolari & Gabriele Fiorentini, 2004. "Indirect Estimation Of Conditionally Heteroskedastic Factor Models," Working Papers wp2004_0409, CEMFI. [Downloadable!]
  12. Michelacci, Claudio & Suarez, Javier, 2002. "Incomplete Wage Posting," CEPR Discussion Papers 3658, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  13. Edward Simpson Prescott, 2004. "Auditing and bank capital regulation," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 47-63. [Downloadable!]
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  14. Enrique Sentana, 2004. "Estimation and Testing of Dynamic Models with Generalised Hyperbolic Innovations," FMG Discussion Papers dp502, Financial Markets Group. [Downloadable!] (restricted)
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  15. Manuel Arellano, 2003. "Modelling Optimal Instrumental Variables For Dynamic Panel Data Models," Working Papers wp2003_0310, CEMFI. [Downloadable!]
  16. Francisco Peñaranda & Enrique Sentana, 2004. "Spanning Tests In Return And Stochastic Discount Factor Mean-Variance Frontiers: A Unifying Approach," Working Papers wp2004_0410, CEMFI. [Downloadable!]
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  17. Edward Simpson Prescott, 2004. "State-contingent bank regulation with unobserved actions and unobserved characteristics," Working Paper 04-02, Federal Reserve Bank of Richmond. [Downloadable!]
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  18. Javier Suarez & Samuel Bentolila & Claudio Michelacci, 2004. "Social Contacts and Occupational Choice," 2004 Meeting Papers 593, Society for Economic Dynamics. [Downloadable!]
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  19. Ana Fernandes, 2005. "Knowledge, Technology Adoption and Financial Innovation," Diskussionsschriften dp0513, Universitaet Bern, Departement Volkswirtschaft. [Downloadable!]
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  20. David S. Evans & A. Jorge Padilla, 2004. "Excessive Prices: Using Economics To Define Administrable Legal Rules," Working Papers wp2004_0416, CEMFI. [Downloadable!]
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  21. Rafael Repullo, 2002. "Capital requirements, market power, and risk-taking in banking," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 150-163.
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  22. Hernandez-Murillo, Ruben & Llobet, Gerard, 2006. "Patent licensing revisited: Heterogeneous firms and product differentiation," International Journal of Industrial Organization, Elsevier, vol. 24(1), pages 149-175, January. [Downloadable!] (restricted)
    Other versions:
  23. Fiorentini, Gabriele & Sentana, Enrique & Calzolari, Giorgio, 2004. "On the validity of the Jarque-Bera normality test in conditionally heteroskedastic dynamic regression models," Economics Letters, Elsevier, vol. 83(3), pages 307-312, June. [Downloadable!] (restricted)
  24. Juan J. Dolado & Vanesa Llorens, 2004. "Gender Wage Gaps By Education In Spain: Glass Floors Vs. Glass Ceilings," Working Papers wp2004_03, CEMFI. [Downloadable!]
  25. Josep Pijoan-Mas, 2004. "Precautionary Savings or Working Longer Hours?," 2004 Meeting Papers 350, Society for Economic Dynamics. [Downloadable!]
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  26. Repullo, Rafael & Suarez, Javier, 2003. "Loan Pricing Under Basel Capital Requirements," CEPR Discussion Papers 3917, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  27. Becker, Sascha & Bentolila, Samuel & Fernandes, Ana & Ichino, Andrea, 2004. "Job Insecurity and Children's Emancipation," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  28. Rafael Repullo, 2004. "Policies For Banking Crises: A Theoretical Framework," Working Papers wp2004_0418, CEMFI. [Downloadable!]
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  29. Pijoan-Mas, Josep, 2006. "Pricing Risk in Economies with Heterogenous Agents and Incomplete Markets," CEPR Discussion Papers 5602, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  30. Caruana, Guillermo & Einav, Liran & Quint, Daniel, 2007. "Multilateral bargaining with concession costs," Journal of Economic Theory, Elsevier, vol. 132(1), pages 147-166, January. [Downloadable!] (restricted)
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  31. Evans, David S & Padilla, Atilano Jorge, 2004. "Designing Antitrust Rules for Assessing Unilateral Practices: A Neo-Chicago Approach," CEPR Discussion Papers 4625, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  32. Victor Aguirregabiria & Pedro Mira, 2004. "Sequential Estimation of Dynamic Discrete Games," Industrial Organization 0406006, EconWPA. [Downloadable!]
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Full references

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. Abel Elizalde, 2006. "CREDIT RISK MODELS IV: UNDERSTANDING AND PRICING CDOs," Working Papers wp2006_0608, CEMFI. [Downloadable!]
  2. Javier Díaz-Giménez & Josep Pijoan-Mas, 2006. "Flat Tax Reforms In The U.S.: A Boon For The Income Poor," Working Papers wp2006_0611, CEMFI. [Downloadable!]
    Other versions:
  3. Antonio Nicolo' & Loriana Pelizzon, 2005. "Credit Derivatives: Capital Requirements and Strategic Contracting," "Marco Fanno" Working Papers 0006, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
  4. Marta González & Josep Pijoan-Mas, 2005. "The Flat Tax Reform: A General Equilibrium Evaluation For Spain," Working Papers wp2005_0505, CEMFI. [Downloadable!]
  5. Jose Ceron & Javier Suarez, 2006. "Hot And Cold Housing Markets: International Evidence," Working Papers wp2006_0603, CEMFI. [Downloadable!]
    Other versions:
  6. Aleix Calveras & Juan-José Ganuza & Gerard Llobet, 2005. "Regulation And Opportunism: How Much Activism Do We Need?," Working Papers wp2005_0508, CEMFI. [Downloadable!]
    Other versions:
  7. Greg Caldwell, 2007. "Best Instruments for Market Discipline in Banking," Working Papers 07-9, Bank of Canada. [Downloadable!]
  8. Beatriz Dominguez & Juan-José Ganuza & Gerard Llobet, 2006. "R&D In The Pharmaceutical Industry: A World Of Small Innovation," Working Papers wp2006_0601, CEMFI. [Downloadable!]
    Other versions:
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