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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. Eduardo Levy Yeyati & Tito Cordella, 1997. "Public Disclosure and Bank Failures," IMF Working Papers 97/96, International Monetary Fund.
  2. Peter J.G. Vlaar, 2000. "Capital requirements and competition in banking industry," Working Paper Series WP-00-18, Federal Reserve Bank of Chicago.
  3. Joe Peek & Eric Rosengren, 1991. "The capital crunch: neither a borrower nor a lender be," Working Papers 91-4, Federal Reserve Bank of Boston.
  4. repec:fth:bfdipa:21/00 is not listed on IDEAS
  5. Matutes, Carmen & Vives, Xavier, 1995. "Imperfect Competition, Risk Taking, and Regulation in Banking," CEPR Discussion Papers 1177, C.E.P.R. Discussion Papers.
  6. Gary Gorton & Andrew Winton, 1995. "Bank Capital Regulation in General Equilibrium," NBER Working Papers 5244, National Bureau of Economic Research, Inc.
  7. P.J.G. Vlaar, 2000. "Capital requirements and competition in the banking industry," WO Research Memoranda (discontinued) 634, Netherlands Central Bank, Research Department.
  8. Stephen F. LeRoy, 1990. "Mutual deposit insurance," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jun8.
  9. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers 9516, Centro de Estudios Monetarios Y Financieros-.
  10. Mitchell A. Petersen & Raghuram G. Rajan, 1994. "The Effect of Credit Market Competition on Lending Relationships," NBER Working Papers 4921, National Bureau of Economic Research, Inc.
  11. Perotti, Enrico C. & Suarez, Javier, 2002. "Last bank standing: What do I gain if you fail?," European Economic Review, Elsevier, vol. 46(9), pages 1599-1622, October.
  12. repec:fth:bfdipa:2/2001 is not listed on IDEAS
  13. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
  14. C. H. Furfine, 2000. "Evidence on the response of US banks to changes in capital requirements," BIS Working Papers 88, Bank for International Settlements.
  15. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers 512, Society for Economic Dynamics.
  16. 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.
  17. Chu, Kam Hon, 1999. "Free Banking and Information Asymmetry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(4), pages 748-62, November.
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Citations

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Cited by:
  1. A.F. Tieman, 2003. "Spillover of Domestic Regulation to Emerging Markets," DNB Staff Reports (discontinued) 90, Netherlands Central Bank.
  2. N. Papanikolaou & M. Delis & S. Brissimis, 2008. "Exploring the nexus between banking sector reform and performance: Evidence from newly acceded EU countries," DEOS Working Papers 0917, Athens University of Economics and Business.
  3. 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.
  4. von Peter, Goetz, 2009. "Asset prices and banking distress: A macroeconomic approach," Journal of Financial Stability, Elsevier, vol. 5(3), pages 298-319, September.
  5. Damjanovic, Tatiana & Damjanovic, Vladislav & Nolan, Charles, 2012. "Universal banking, competition and risk in a macro model," SIRE Discussion Papers 2012-19, Scottish Institute for Research in Economics (SIRE).
  6. Leo de Haan & Jan Kakes, 2007. "Are non-risk based capital requirements for insurance companies binding?," DNB Working Papers 145, Netherlands Central Bank, Research Department.
  7. Jakob Bosma, 2011. "Communicating Bailout Policy and Risk Taking in the Banking Industry," DNB Working Papers 277, Netherlands Central Bank, Research Department.
  8. International Monetary Fund, 2008. "Innovation in Banking and Excessive Loan Growth," IMF Working Papers 08/188, International Monetary Fund.
  9. Wilko Bolt & Alexander F. Tieman, 2006. "On Myopic Equilibria in Dynamic Games with Endogenous Discounting," IMF Working Papers 06/302, International Monetary Fund.
  10. 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.
  11. Chen, Xiaofen, 2007. "Banking deregulation and credit risk: Evidence from the EU," Journal of Financial Stability, Elsevier, vol. 2(4), pages 356-390, March.
  12. Philipp Hartmann & Elena Carletti, 2002. "Competition and Stability: What's Special about Banking?," FMG Special Papers sp140, Financial Markets Group.
  13. Murinde, Victor & Zhao, Tianshu, 2009. "Bank competition, risk taking and productive efficiency: Evidence from Nigeria's banking reform experiments," Stirling Economics Discussion Papers 2009-23, University of Stirling, Division of Economics.
  14. Goetz von Peter, 2004. "Asset Prices and Banking Distress: A Macroeconomic Approach," Finance 0411034, EconWPA.
  15. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2013. "Universal vs separated banking with deposit insurance in a macro model," Discussion Papers 1308, Exeter University, Department of Economics.

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