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Banking Competition, Risk and Regulation

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  • Wilko Bolt
  • Alexander F. Tieman

Abstract

In a dynamic framework, commercial banks compete for customers by setting acceptance criteria for granting loans, while taking into account regulatory requirements. By easing its acceptance criteria a bank faces a trade‐off between attracting more demand for loans, thus making higher per‐period profits, and deterioration in the quality of its loan portfolio, thus tolerating a higher risk of failure. Our main results state that more stringent capital adequacy requirements lead banks to set stricter acceptance criteria, and that increased competition in the banking industry leads to riskier bank behaviour. It is shown that risk‐adjusted regulation is effective. In an extension of our basic model, we show that it may be beneficial for a bank to hold more equity than prescribed by the regulator, even though issuing equity is more expensive than attracting deposits.

Suggested Citation

  • Wilko Bolt & Alexander F. Tieman, 2004. "Banking Competition, Risk and Regulation," Scandinavian Journal of Economics, Wiley Blackwell, vol. 106(4), pages 783-804, December.
    • Handle: RePEc:bla:scandj:v:106:y:2004:i:4:p:783-804
    DOI: 10.1111/j.0347-0520.2004.00388.x
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    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure

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