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Bank Capital Requirements and Managerial Self-Interest

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  • Arturo Bris
  • Salvatore Cantale
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    Abstract

    We analyze the effect of capital adequacy requirements on bank risk policy when managers and shareholders have different information about the quality of the loan portfolio. In a two-period model in which shareholders implement the optimal contract with managers, we show that the level of managerial effort (and therefore the quality of the loan portfolio) is higher when shareholders cannot observe the manager's action. When information regarding the bank loan portfolio is symmetric, capital requirements help reduce the excess risk-taking problem that deposit insurance creates. Taking as given optimal regulation on capital requirements and deposit insurance, we show that the moral hazard problem in banks leads to a reduction in the banks' loan portfolio through an increase in the managerial effort in loan supervision. Only high-quality loans are accepted by the bank, but some profitable investments are bypassed because managers are more interested in maximizing their compensation (diluting the stock value) than in maximizing the shareholders' wealth. Thus we conclude that the riskiness of banks may be suboptimally low under

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    Bibliographic Info

    Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm105.

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    Date of creation: 01 Dec 1998
    Date of revision: 01 Aug 2000
    Handle: RePEc:ysm:somwrk:ysm105

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    Web page: http://icf.som.yale.edu/
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    1. Allen N. Berger & Gregory F. Udell, 1994. "Did risk-based capital allocate bank credit and cause a "credit crunch" in the United States?," Proceedings, Federal Reserve Bank of Cleveland, pages 585-633.
    2. Joe Peek & Eric Rosengren, 1993. "Bank regulation and the credit crunch," Working Papers 93-2, Federal Reserve Bank of Boston.
    3. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
    4. Chan, Yuk-Shee & Greenbaum, Stuart I & Thakor, Anjan V, 1992. " Is Fairly Priced Deposit Insurance Possible?," Journal of Finance, American Finance Association, vol. 47(1), pages 227-45, March.
    5. Kim, Daesik & Santomero, Anthony M, 1988. " Risk in Banking and Capital Regulation," Journal of Finance, American Finance Association, vol. 43(5), pages 1219-33, December.
    6. Gary Gorton & Andrew Winton, 1995. "Bank Capital Regulation in General Equilibrium," NBER Working Papers 5244, National Bureau of Economic Research, Inc.
    7. Gennotte, Gerard & Pyle, David, 1991. "Capital controls and bank risk," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 805-824, September.
    8. Walter Novaes & Luigi Zingales, 1995. "Capital Structure Choice when Managers are in Control: Entrenchment versus Efficiency," NBER Working Papers 5384, National Bureau of Economic Research, Inc.
    9. Allen N. Berger & Gregory F. Udell, 1993. "Did risk-based capital allocate bank credit and cause a credit crunch in the U.S.?," Finance and Economics Discussion Series 93-41, Board of Governors of the Federal Reserve System (U.S.).
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