Capital requirements and competition in the banking industry
AbstractThis paper focuses on the interaction between regulation and competition in an industrial organisation model. We analyse how capital requirements affect the profitability of two banks that compete as Cournet duopolists on a market for loans. Bank management of both banks choose optimal levels of loans provided, equity ratio and effort to reduce loan losses so as to maximise profits. From the regulator's point of view, the free market solution is not optimal as private banks do not take into account the consumer surplus and the social cost of bankruptcy (financial stability aspects). It is shown that capital requirements may improve welfare, even under conditions that both banks would never default. Moreover, we find that higher capital requirements impose a higher burden on the inefficient bank than on the efficient one, even though the requirement may only be binding for the efficient bank. If the inefficient bank chooses a strategy that might result in bankrutpcy, capital requirements are particularly welfare improving.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 634.
Date of creation: 2000
Date of revision:
Cournot duopoly; Capital requirements; Profit paradox; level playing field;
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.:
- Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, June.
- Bhattacharya, Sudipto & Boot, Arnoud W A & Thakor, Anjan V, 1998.
"The Economics of Bank Regulation,"
Journal of Money, Credit and Banking,
Blackwell Publishing, vol. 30(4), pages 745-70, November.
- Marshall, David A. & Prescott, Edward Simpson, 2001.
"Bank capital regulation with and without state-contingent penalties,"
Carnegie-Rochester Conference Series on Public Policy,
Elsevier, vol. 54(1), pages 139-184, June.
- 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.
- 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.
- Donsyah Yudistira, 2002. "The Impact of Bank Capital Requirements in Indonesia," Finance 0212002, EconWPA, revised 18 May 2003.
- W. Bolt & A. F. Tieman, 2001.
"Banking competition, risk, and regulation,"
WO Research Memoranda (discontinued)
647, Netherlands Central Bank, Research Department.
- Leonardo Gambacorta & Paolo Emilio Mistrulli, 2003. "Bank Capital and Lending Behaviour: Empirical Evidence for Italy," Temi di discussione (Economic working papers) 486, Bank of Italy, Economic Research and International Relations Area.
- 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.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Rob Vet).
If references are entirely missing, you can add them using this form.