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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- 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.
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- Michael H. Riordan, 1992. "Competition and Bank Performance: A Theoretical Perspective," Papers 0026, Boston University - Industry Studies Programme.
- Douglas W. Diamond, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 393-414.
- Kahane, Yehuda, 1977. "Capital adequacy and the regulation of financial intermediaries," Journal of Banking & Finance, Elsevier, vol. 1(2), pages 207-218, October.
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