Bank capital regulation in a cap option framework
Synergy-banking management under capital regulation is done through a gluing together of lending and deposit-taking. Under this viewpoint, we argue that the cap options theory of corporate security valuation can be applied to the contingent claims of the synergy-banking firm. The equity holders of the bank own a cap option on the bank equity return which can be considered against their expected investment opportunity costs captured by the cap rates. We show that an increase in the cap rate increases the risky loans held by the bank at a lower interest margin, and then increases the equity risk and the default risk of equity. An increase in the capital-to-deposits ratio decreases the risky loans held by the bank at an increased margin, and decreases the bank's equity risk and the default probability in the bank's equity. Capital regulation as such makes the bank more prudent and less prone to risk-taking, thereby contributing to the stability of the banking system. Our findings may support increased capital requirements in the spirit of the Dodd–Frank Act of the Basel Accord (Eubanks, 2010).
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
When requesting a correction, please mention this item's handle: RePEc:eee:reveco:v:25:y:2013:i:c:p:66-74. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If references are entirely missing, you can add them using this form.