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Bank capital and risk taking


  • Alistair Milne
  • A Elizabeth Whalley


Bank risk-taking and capitalisation is studied in a continuous time model with a closed form solution, assuming uncertain cash flow, random regulatory audit, and a constraint on equity issue. Capital reserves are built up towards a desired level as an insurance against the threat of liquidation. Risk-taking is a discontinuous function of the level of capital. A solution is derived for the liquidation rate in steady state and the determinants of charter value are investigated. Minimum capital standards are found to have little long-term impact on bank behaviour. Audit frequency is the principal tool for restraining moral hazard.

Suggested Citation

  • Alistair Milne & A Elizabeth Whalley, 1999. "Bank capital and risk taking," Bank of England working papers 90, Bank of England.
  • Handle: RePEc:boe:boeewp:90

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    Cited by:

    1. Joël Petey, 2004. "Les déterminants du risque d'insolvabilité dans l'industrie bancaire.. Une approche en termes de frontière de production," Recherches économiques de Louvain, De Boeck Université, vol. 70(4), pages 401-424.
    2. Milne, Alistair, 2002. "Bank capital regulation as an incentive mechanism: Implications for portfolio choice," Journal of Banking & Finance, Elsevier, vol. 26(1), pages 1-23, January.
    3. Ashraf, Dawood & Ramady, Mohamed & Albinali, Khalid, 2016. "Financial fragility of banks, ownership structure and income diversification: Empirical evidence from the GCC region," Research in International Business and Finance, Elsevier, vol. 38(C), pages 56-68.
    4. Isohätälä, Jukka & Milne, Alistair & Robertson, Donald, 2014. "The net worth trap: investment and output dynamics in the presence of financing constraints," Research Discussion Papers 26/2014, Bank of Finland.
    5. Larsson, Bo & Wijkander, Hans, 2012. "Banking on Regulations?," Research Papers in Economics 2012:3, Stockholm University, Department of Economics.
    6. Bülbül, Dilek & Lambert, Claudia, 2012. "Credit portfolio modelling and its effect on capital requirements," Discussion Papers 11/2012, Deutsche Bundesbank.
    7. Kilponen, Juha & Milne, Alistair, 2007. "The lending channel under optimal choice of monetary policy," Research Discussion Papers 33/2007, Bank of Finland.

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