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Capital Requirements, Market Power and Risk-Taking in Banking

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  • Repullo, Rafael

Abstract

This Paper presents a dynamic model of imperfect competition in banking where banks can invest in a prudent or a gambling asset. We show that if intermediation margins are small, the banks’ franchise values will be small, and in the absence of regulation only a gambling equilibrium will exist. In this case, either flat-rate capital requirements or binding deposit rate ceilings can ensure the existence of a prudent equilibrium, although both have a negative impact on deposit rates. Such impact does not obtain with either risk-based capital requirements or non-binding deposit rate ceilings, but only the former are always effective in controlling risk-shifting incentives.

Suggested Citation

  • Repullo, Rafael, 2003. "Capital Requirements, Market Power and Risk-Taking in Banking," CEPR Discussion Papers 3721, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:3721
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    More about this item

    Keywords

    bank regulation; capital requirements; deposit rate ceilings; franchise values; imperfect competition; moral hazard; risk-shifting;

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • 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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