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Risk-Taking and Solvency Regulation in Banking – A Note –

Author

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  • Franz R. Hahn

    (Österreichisches Institut für Wirtschaftsforschung, Postfach 91, A-1030 Wien/Österreich)

Abstract

In a dynamic setting intertemporal effects can arise that render capital rules in banking as advocated by the Basel Committee of Banking Supervision counterproductive. It is quite possible that the banks' desire for excessive risk-taking is being reinforced by a binding capital rule such as the Basel risk-based capital requirement. In this paper an attempt is made to explore the impact of the so-called precommitment approach, proposed as an alternative to risk-based minimum capital rules, on the risk-taking behavior of banks. According to this proposal banks are free to self-assess their maximum possible losses, but make a commitment to the regulator to hold at least as much capital as is needed to cover these losses. It turns out that in a standard dynamic setting the precommitment approach is superior to the prevailing minimum capital rule in that the risk-neutral bank which maximizes its expected value of equity subject to a precommitted liquidity constraint chooses a risk-level which is socially optimal.

Suggested Citation

  • Franz R. Hahn, 2010. "Risk-Taking and Solvency Regulation in Banking – A Note –," Credit and Capital Markets, Credit and Capital Markets, vol. 43(3), pages 339-347.
  • Handle: RePEc:kuk:journl:v:43:y:2010:i:3:p:339-347
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    Cited by:

    1. Franz R. Hahn & Werner Hölzl, 2012. "Effects of the New Capital Requirements of Basel III on the Financing of Small and Medium-sized Enterprises in Austria," Austrian Economic Quarterly, WIFO, vol. 17(3), pages 168-186, August.

    More about this item

    JEL classification:

    • 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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