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Banking competition, risk and regulation

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Author Info

  • W. Bolt
  • A.F. Tieman

Abstract

In a dynamic framework banks compete for customers by setting lending conditions for the loans they supply, taking into account the capital adequacy requirements posed by the regulator. By easing its lend- ing conditions a bank faces a tradeoff between attracting more demand for loans, thus making higher per-period profits, and a deterioration of the quality of its loan portfolio, thus a higher risk of failure. Our main results state that more stringent capital adequacy requirements lead commercial banks to set more stringent loan conditions to their customers, and we show that increased competition in the banking in- dustry leads banks to behave more risky. In this model we also look at risk-adjusted capital requirements and show that risk-based regulation is effective. We extend the basic model to have banks choose both their lending conditions and the level of bank capital. In this extended model it turns out that it may be beneficial for a bank to hold more equity than prescribed by the regulator, even though equity is more expensive than attracting deposits. We show that the same conclusions with respect to the effectiveness of regulation hold as in the standard model.

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Bibliographic Info

Paper provided by Netherlands Central Bank in its series DNB Staff Reports (discontinued) with number 70.

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Length: 32 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:dnb:staffs:70

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Related research

Keywords: Banking competition; risk profile; failure rate; capital requirements;

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References

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  1. repec:fth:bfdipa:21/00 is not listed on IDEAS
  2. Jokivuolle, Esa & Kauko, Karlo, 2001. "The New Basel Accord: some potential implications of the new standards for credit risk," Research Discussion Papers 2/2001, Bank of Finland.
  3. Perotti, Enrico C & Suarez, Javier, 2001. "Last Bank Standing: What Do I Gain if You Fail?," CEPR Discussion Papers 2933, C.E.P.R. Discussion Papers.
  4. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May.
  5. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937.
  6. Giovanni Dell'Ariccia & Ezra Friedman & Robert Marquez, 1999. "Adverse Selection as a Barrier to Entry in the Banking Industry," RAND Journal of Economics, The RAND Corporation, vol. 30(3), pages 515-534, Autumn.
  7. Cordella, Tito & Levy Yeyati, Eduardo, 1998. "Public Disclosure and Bank Failures," CEPR Discussion Papers 1886, C.E.P.R. Discussion Papers.
  8. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers 9516, Centro de Estudios Monetarios Y Financieros-.
  9. Stephen F. LeRoy, 1990. "Mutual deposit insurance," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue Jun 8.
  10. Joe Peek & Eric Rosengren, 1993. "The Capital Crunch: Neither A Borrower Nor A Lender Be," Boston College Working Papers in Economics 243, Boston College Department of Economics.
  11. P.J.G. Vlaar, 2000. "Capital requirements and competition in the banking industry," WO Research Memoranda (discontinued) 634, Netherlands Central Bank, Research Department.
  12. Matutes, Carmen & Vives, Xavier, 2000. "Imperfect competition, risk taking, and regulation in banking," European Economic Review, Elsevier, vol. 44(1), pages 1-34, January.
  13. Peter J.G. Vlaar, 2000. "Capital requirements and competition in banking industry," Working Paper Series WP-00-18, Federal Reserve Bank of Chicago.
  14. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers 512, Society for Economic Dynamics.
  15. repec:fth:bfdipa:2/2001 is not listed on IDEAS
  16. Chu, Kam Hon, 1999. "Free Banking and Information Asymmetry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(4), pages 748-62, November.
  17. C. H. Furfine, 2000. "Evidence on the response of US banks to changes in capital requirements," BIS Working Papers 88, Bank for International Settlements.
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Citations

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Cited by:
  1. Wilko Bolt & Alexander F. Tieman, 2006. "On Myopic Equilibria in Dynamic Games with Endogenous Discounting," IMF Working Papers 06/302, International Monetary Fund.
  2. de Haan, Leo & Kakes, Jan, 2010. "Are non-risk based capital requirements for insurance companies binding?," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1618-1627, July.
  3. Brissimis, Sophocles N. & Delis, Manthos D. & Papanikolaou, Nikolaos I., 2008. "Exploring the nexus between banking sector reform and performance: Evidence from newly acceded EU countries," Journal of Banking & Finance, Elsevier, vol. 32(12), pages 2674-2683, December.
  4. International Monetary Fund, 2008. "Innovation in Banking and Excessive Loan Growth," IMF Working Papers 08/188, International Monetary Fund.
  5. Goetz von Peter, 2004. "Asset prices and banking distress: a macroeconomic approach," BIS Working Papers 167, Bank for International Settlements.
  6. A.F. Tieman, 2000. "Spillover of domestic regulation to emerging markets," WO Research Memoranda (discontinued) 628, Netherlands Central Bank, Research Department.
  7. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2012. "Universal banking, competition and risk in a macro model," Discussion Papers 1201, Exeter University, Department of Economics.
  8. Agoraki, Maria-Eleni K. & Delis, Manthos D. & Pasiouras, Fotios, 2011. "Regulations, competition and bank risk-taking in transition countries," Journal of Financial Stability, Elsevier, vol. 7(1), pages 38-48, January.
  9. Philipp Hartmann & Elena Carletti, 2002. "Competition and stability: what's special about banking?," Working Paper Series 146, European Central Bank.
  10. Chen, Xiaofen, 2007. "Banking deregulation and credit risk: Evidence from the EU," Journal of Financial Stability, Elsevier, vol. 2(4), pages 356-390, March.
  11. Jakob Bosma, 2011. "Communicating Bailout Policy and Risk Taking in the Banking Industry," DNB Working Papers 277, Netherlands Central Bank, Research Department.
  12. Goetz von Peter, 2004. "Asset Prices and Banking Distress: A Macroeconomic Approach," Finance 0411034, EconWPA.
  13. W. Bolt & A.F. Tieman, 2001. "When Basle II doesn't work: Contingency Rules versus Fixed Requirements," WO Research Memoranda (discontinued) 681, Netherlands Central Bank, Research Department.

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