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Risk in Banking and Capital Regulation

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  • Kim, Daesik
  • Santomero, Anthony M

Abstract

This paper investigates the role of bank capital regulation in risk control. It is known that banks choose portfolios of higher risk because of inefficiently priced deposit insurance. Bank capital regulation is a way to redress this bias toward risk. Utilizing the mean-variance model, the following results are shown: (1) the use of simple capital ratios in regulation is an ineffective means to bound the insolvency risk of banks; (2) as a solution to problems of the capital ratio regulation, the "theoretically correct" risk weights under the risk-b ased capital plan are explicitly derived; and (3) the "theoretically correct" risk weights are restrictions on asset composition, which alters the optimal portfolio choice of banking firms. Copyright 1988 by American Finance Association.

Suggested Citation

  • Kim, Daesik & Santomero, Anthony M, 1988. " Risk in Banking and Capital Regulation," Journal of Finance, American Finance Association, vol. 43(5), pages 1219-1233, December.
  • Handle: RePEc:bla:jfinan:v:43:y:1988:i:5:p:1219-33
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