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On the Influence of capital Requirements on Competition and Risk taking in Banking

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Author Info

  • Peter J.G. Vlaar

Abstract

This paper focuses on the interaction between regulation and competition in an industrial organisation model. We analyse how capital requirements a.ect the pro.tability of two banks that compete as Cournot duopolists on a market for loans. Bank management of both banks choose optimal levels of loans provided, equity ratio and e.ort to reduce loan losses so as to maximise pro.ts. It is shown that the introduction of a just binding capital constraint improves the pro.tability of the constrained bank, whereas the pro.tability of its unrestricted competitor declines. Especially, if an ine.cient bank chooses a strategy that might result in bankruptcy, capital requirements are welfare improving. However, also under conditions that both banks would also never default in the absence of regulation, mild capital requirements can be bene.cial as they stimulate banks to provide more loans. Too high requirements on the other hand relatively favour the ine.cient bank, and result in welfare losses.

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File URL: http://www.dnb.nl/binaries/sr102_tcm46-146879.pdf
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Bibliographic Info

Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 102.

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Length: 33 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:dnb:staffs:102

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Related research

Keywords: Cournot duopoly; Capital requirements; Pro?t paradox;

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References

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  1. David A. Marshall & Edward S. Prescott, 2000. "Bank capital regulation with and without state-contingent penalties," Working Paper Series WP-00-10, Federal Reserve Bank of Chicago.
  2. 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, vol. 90(1), pages 147-165, March.
  3. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
  4. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers 9516, Centro de Estudios Monetarios Y Financieros-.
  5. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
  6. Arnoud Boot & Silva Dezõelan & Todd Milbourn, 1999. "Regulatory Distortions in a Competitive Financial Services Industry," Journal of Financial Services Research, Springer, vol. 16(2), pages 249-259, December.
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Cited by:
  1. Imola Drigă & Codruța Dura & Ilie Răscolean, 2011. "Overview of the Caampl Early Warning System in Romanian Banking," Annals of the University of Petrosani, Economics, University of Petrosani, Romania, vol. 11(2), pages 71-80.

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