Market Structure, Monitoring and Capital Adequacy Regulation
The paper discusses effort-aversion moral hazard in banks. When the evaluation and monitoring of loans requires private management effort, monitoring efforts are sensitive to the intensity of competition in the credit market. Equilibrium loan rates incorporate an oligopoly premium and a provision for bad loans. While competition reduces the oligopoly premium it also reduces monitoring incentives. Therefore, in line with recent evidence from Switzerland, loan provisions increase under deregulation, leaving the overall effect on firms' cost of finance ambiguous. Capital adequacy regulation tends to increase effort-aversion moral hazard. Furthermore it is shown that capital standards may amplify business cycles and, counter-productively, increase systemic risk. The model suggests a certain degree of complementarity between prudential and structural regulation for the banking industry.
Volume (Year): 132 (1996)
Issue (Month): IV (December)
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References listed on IDEAS
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- Steven R. Grenadier & Brian J. Hall, 1995. "Risk-Based Capital Standards and the Riskiness of Bank Portfolios: Credit and Factor Risks," NBER Working Papers 5178, National Bureau of Economic Research, Inc.
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NBER Working Papers
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- Besanko, David & Kanatas, George, 1993. "Credit Market Equilibrium with Bank Monitoring and Moral Hazard," Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 213-32.
- repec:oup:restud:v:51:y:1984:i:3:p:393-414 is not listed on IDEAS
- Kahane, Yehuda, 1977. "Capital adequacy and the regulation of financial intermediaries," Journal of Banking & Finance, Elsevier, vol. 1(2), pages 207-218, October.
- Steven R. Renadier & Brian J. Hall, 1995. "Risk-Based Capital Standards and the Riskiness of Bank Portfolios: Credit and Factor Risks," Harvard Institute of Economic Research Working Papers 1718, Harvard - Institute of Economic Research.
- Gennotte, Gerard & Pyle, David, 1991. "Capital controls and bank risk," Journal of Banking & Finance, Elsevier, vol. 15(4-5), pages 805-824, September.
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