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Capital requirements, market power, and risk-taking in banking

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  • Rafael Repullo

Abstract

This Paper presents a dynamic model of imperfect competition in banking where banks can invest in a prudent or a gambling asset. We show that if intermediation margins are small, the banks’ franchise values will be small, and in the absence of regulation only a gambling equilibrium will exist. In this case, either flat-rate capital requirements or binding deposit rate ceilings can ensure the existence of a prudent equilibrium, although both have a negative impact on deposit rates. Such impact does not obtain with either risk-based capital requirements or non-binding deposit rate ceilings, but only the former are always effective in controlling risk-shifting incentives.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Chicago in its series Proceedings with number 809.

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Length: 150-163
Date of creation: 2002
Date of revision:
Publication status: Published in Conference on Bank Structure and Competition (2002 : 38th) ; Financial market behavior and appropriate regulation over the business cycle
Handle: RePEc:fip:fedhpr:809

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Keywords: Bank capital ; Bank competition ; Bank assets;

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References

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  1. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
  2. Furlong, Frederick T. & Keeley, Michael C., 1989. "Capital regulation and bank risk-taking: A note," Journal of Banking & Finance, Elsevier, vol. 13(6), pages 883-891, December.
  3. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
  4. Yuk-Shee Chan & Stuart I. Greenbaum & Anjan V. Thakor, 2004. "Is Fairly Priced Deposit Insurance Possible?," Finance 0411018, EconWPA.
  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. Repullo, Rafael, 2000. "Who Should Act as Lender of Last Resort? An Incomplete Contracts Model," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 580-605, August.
  7. 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.
  8. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
  9. Besanko, David & Kanatas, George, 1996. "The Regulation of Bank Capital: Do Capital Standards Promote Bank Safety?," Journal of Financial Intermediation, Elsevier, vol. 5(2), pages 160-183, April.
  10. Frederick T. Furlong & Michael C. Keeley, 1991. "Capital regulation and bank risk-taking: a note (reprinted from Journal of Banking and Finance)," Economic Review, Federal Reserve Bank of San Francisco, issue Sum, pages 34-39.
  11. Rochet, Jean-Charles, 1992. "Capital requirements and the behaviour of commercial banks," European Economic Review, Elsevier, vol. 36(5), pages 1137-1170, June.
  12. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, December.
  13. Chiappori, P.A. & Perez-Castrillo, D. & Verdier, T., 1992. "Spatial Competition in the Banking System: Localization, Cross Subsidies and the Regulation of Deposit Rates," DELTA Working Papers 92-15, DELTA (Ecole normale supérieure).
  14. Gennotte, Gerard & Pyle, David, 1991. "Capital controls and bank risk," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 805-824, September.
  15. Steven C. Salop, 1979. "Monopolistic Competition with Outside Goods," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 141-156, Spring.
  16. Keeley, Michael C, 1990. "Deposit Insurance, Risk, and Market Power in Banking," American Economic Review, American Economic Association, vol. 80(5), pages 1183-1200, December.
  17. Matutes, Carmen & Vives, Xavier, 1996. "Competition for Deposits, Fragility, and Insurance," Journal of Financial Intermediation, Elsevier, vol. 5(2), pages 184-216, April.
  18. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  19. 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.
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