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Why do banks hold capital in excess of regulatory requirements? A functional approach

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Author Info
Diemo Dietrich (Halle Institute for Economic Research)
Uwe Vollmer (University of Leipzig)

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Abstract

This paper provides an explanation for the observation that banks hold on average a capital ratio in excess of regulatory requirements. We use a functional approach to banking based on Diamond and Rajan (2001) to demonstrate that banks can use capital ratios as a strategic tool for renegotiating loans with borrowers. As capital ratios affect the ability of banks to collect loans in a nonmonotonic way, a bank may be forced to exceed capital requirements. Moreover, high capital ratios may also constrain the amount a banker can borrow from investors. Consequently, the size of the banking sector may shrink.

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File URL: http://129.3.20.41/eps/fin/papers/0407/0407006.pdf
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Paper provided by EconWPA in its series Finance with number 0407006.

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Length: 23 pages
Date of creation: 08 Jul 2004
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Handle: RePEc:wpa:wuwpfi:0407006

Note: Type of Document - pdf; pages: 23
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Web page: http://129.3.20.41

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Find related papers by JEL classification:
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages
G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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References listed on IDEAS
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  1. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers sp130, Financial Markets Group. [Downloadable!] (restricted)
  2. Douglas W. Diamond & Raghuram G. Rajan, 2000. "A Theory of Bank Capital," Journal of Finance, American Finance Association, vol. 55(6), pages 2431-2465, December. [Downloadable!] (restricted)
    Other versions:
  3. Rubinstein, Ariel, 1982. "Perfect Equilibrium in a Bargaining Model," Econometrica, Econometric Society, vol. 50(1), pages 97-109, January. [Downloadable!] (restricted)
  4. 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. [Downloadable!]
  5. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November. [Downloadable!] (restricted)
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  6. Estrella, Arturo, 2004. "The cyclical behavior of optimal bank capital," Journal of Banking & Finance, Elsevier, vol. 28(6), pages 1469-1498, June. [Downloadable!] (restricted)
  7. Anil Kashyap & Jeremy C. Stein, 2004. "Cyclical implications of the Basel II capital standards," Economic Perspectives, Federal Reserve Bank of Chicago, issue Q I, pages 18-31. [Downloadable!]
  8. repec:fth:bfdipa:2/2001 is not listed on IDEAS
  9. Rime, Bertrand, 2001. "Capital requirements and bank behaviour: Empirical evidence for Switzerland," Journal of Banking & Finance, Elsevier, vol. 25(4), pages 789-805, April. [Downloadable!] (restricted)
  10. Perotti, Enrico C & Spier, Kathryn E, 1993. "Capital Structure as a Bargaining Tool: The Role of Leverage in Contract Renegotiation," American Economic Review, American Economic Association, vol. 83(5), pages 1131-41, December. [Downloadable!] (restricted)
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  11. Douglas W. Diamond & Raghuram G. Rajan, 1998. "Liquidity risk, liquidity creation and financial fragility: a theory of banking," Proceedings, Federal Reserve Bank of San Francisco, issue Sep.
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