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Bank capital and the optimal capital structure of an economy

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  • Gersbach, Hans

Abstract

In this paper, we provide an economy-wide perspective on equity and debt across banks and industrial firms when both are faced with incentive problems and equity is scarce. Increasing bank equity may mitigate the bank-level moral hazard but exacerbates the firm-level moral hazard due to the reduction of firm equity. Competition among banks tends to result in an inefficiently low level of equity. In this case, imposing capital requirements on banks leads to a socially optimal capital structure for the economy in the sense of maximizing aggregate output. Such capital regulation is second-best and must balance three costs: excessive risk-taking by banks, credit restrictions that banks impose on firms with low equity, and credit restrictions due to high loan-interest rates. We discuss the implications of these findings for capital requirements, competition policy and banking crises.

Suggested Citation

  • Gersbach, Hans, 2013. "Bank capital and the optimal capital structure of an economy," European Economic Review, Elsevier, vol. 64(C), pages 241-255.
  • Handle: RePEc:eee:eecrev:v:64:y:2013:i:c:p:241-255 DOI: 10.1016/j.euroecorev.2013.07.010
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    References listed on IDEAS

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    Cited by:

    1. Gersbach, Hans & Haller, Hans & Müller, Jürg, 2015. "The macroeconomics of Modigliani–Miller," Journal of Economic Theory, Elsevier, vol. 157(C), pages 1081-1113.
    2. Pierre-Richard Agénor & L. Pereira da Silva, 2016. "Capital Requirements, Risk Taking and Welfare in a Growing Economy," Centre for Growth and Business Cycle Research Discussion Paper Series 226, Economics, The Univeristy of Manchester.
    3. Pierre-Richard Agénor & L. Pereira da Silva, 2016. "Capital Requirements, Risk Taking and Welfare in a Growing Economy," Centre for Growth and Business Cycle Research Discussion Paper Series 226, Economics, The Univeristy of Manchester.

    More about this item

    Keywords

    Financial intermediation; Double incentive problems; Bank capital; Banking regulation; Capital structure of the economy;

    JEL classification:

    • D41 - Microeconomics - - Market Structure, Pricing, and Design - - - Perfect Competition
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • G2 - Financial Economics - - Financial Institutions and Services

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