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Banking competition, risk, and regulation

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  • 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 lending 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 industry 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, Research Department in its series WO Research Memoranda (discontinued) with number 647.

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Date of creation: 2001
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Handle: RePEc:dnb:wormem:647

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

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References

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  1. Tito Cordella & Eduardo Levy Yeyati, 1998. "Public Disclosure and Bank Failures," IMF Staff Papers, Palgrave Macmillan, vol. 45(1), pages 110-131, March.
  2. Matutes, Carmen & Vives, Xavier, 2000. "Imperfect competition, risk taking, and regulation in banking," European Economic Review, Elsevier, vol. 44(1), pages 1-34, January.
  3. P.J.G. Vlaar, 2000. "Capital requirements and competition in the banking industry," WO Research Memoranda (discontinued) 634, Netherlands Central Bank, Research Department.
  4. Stephen F. LeRoy, 1990. "Mutual deposit insurance," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jun8.
  5. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
  6. 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.
  7. Gary Gorton & Andrew Winton, . "Bank Capital Regulation in General Equilibrium," Rodney L. White Center for Financial Research Working Papers 17-95, Wharton School Rodney L. White Center for Financial Research.
  8. 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.
  9. C. H. Furfine, 2000. "Evidence on the response of US banks to changes in capital requirements," BIS Working Papers 88, Bank for International Settlements.
  10. Peter J.G. Vlaar, 2000. "Capital requirements and competition in banking industry," Working Paper Series WP-00-18, Federal Reserve Bank of Chicago.
  11. 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.
  12. repec:fth:bfdipa:2/2001 is not listed on IDEAS
  13. 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.
  14. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers 512, Society for Economic Dynamics.
  15. Chu, Kam Hon, 1999. "Free Banking and Information Asymmetry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(4), pages 748-62, November.
  16. repec:fth:bfdipa:21/00 is not listed on IDEAS
  17. 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.
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Citations

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Cited by:
  1. Carletti, Elena & Hartmann, Philipp, 2002. "Competition and stability: what's special about banking?," Working Paper Series 0146, European Central Bank.
  2. von Peter, Goetz, 2009. "Asset prices and banking distress: A macroeconomic approach," Journal of Financial Stability, Elsevier, vol. 5(3), pages 298-319, September.
  3. 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.
  4. 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.
  5. 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.
  6. 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.
  7. International Monetary Fund, 2008. "Innovation in Banking and Excessive Loan Growth," IMF Working Papers 08/188, International Monetary Fund.
  8. Wilko Bolt & Alexander Tieman, 2005. "On Myopic Equilibria in Dynamic Games with Endogenous Discounting," DNB Working Papers 070, Netherlands Central Bank, Research Department.
  9. 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.
  10. Tatiana Damjanovic & Vladislav Damjanovic & Charles Nolan, 2012. "Universal banking, competition and risk in a macro model," Discussion Papers 1201, Exeter University, Department of Economics.
  11. Goetz von Peter, 2004. "Asset Prices and Banking Distress: A Macroeconomic Approach," Finance 0411034, EconWPA.
  12. 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.
  13. A.F. Tieman, 2003. "Spillover of Domestic Regulation to Emerging Markets," DNB Staff Reports (discontinued) 90, Netherlands Central Bank.
  14. Chen, Xiaofen, 2007. "Banking deregulation and credit risk: Evidence from the EU," Journal of Financial Stability, Elsevier, vol. 2(4), pages 356-390, March.
  15. Jakob Bosma, 2011. "Communicating Bailout Policy and Risk Taking in the Banking Industry," DNB Working Papers 277, Netherlands Central Bank, Research Department.

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