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Basel III capital requirements and heterogeneous banks

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  • Müller, Carola

Abstract

I develop a theoretical model to examine the effect of capital requirements on risk taking and market structure of banks. Within a portfolio choice model, I allow for heterogeneous productivity among banks and consider the simultaneous capital regulation with a leverage ratio and a risk-weighted ratio. Regulators face a trade-off between the efficient allocation of resources and financial stability. In an oligopolistic market, risk-weighted requirements incentivise banks with high productivity to lend to low-risk firms. When a leverage ratio is introduced, these banks lose market shares to less productive competitors and react with risk-shifting into high-risk loans. While average productivity in the low-risk market falls, market shares in the high-risk market are dispersed across new entrants with high as well as low productivity.

Suggested Citation

  • Müller, Carola, 2018. "Basel III capital requirements and heterogeneous banks," IWH Discussion Papers 14/2018, Halle Institute for Economic Research (IWH), revised 2018.
    • Handle: RePEc:zbw:iwhdps:142018
    Note: A completely revised version of this paper has been published as Müller, Carola: Capital Requirements, Market Structure, and Heterogeneous Banks. IWH Discussion Papers 15/2022. Halle (Saale) 2022. http://hdl.handle.net/10419/256924
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    File URL: https://www.econstor.eu/bitstream/10419/184998/1/iwh-dp-2018-14.pdf
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    More about this item

    Keywords

    banking regulation; heterogeneous banks; banking competition; capital requirements; leverage ratio; Basel III;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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