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On the Influence of capital Requirements on Competition and Risk taking in Banking

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  • Peter J.G. Vlaar

Abstract

This paper focuses on the interaction between regulation and competition in an industrial organisation model. We analyse how capital requirements a.ect the pro.tability of two banks that compete as Cournot duopolists on a market for loans. Bank management of both banks choose optimal levels of loans provided, equity ratio and e.ort to reduce loan losses so as to maximise pro.ts. It is shown that the introduction of a just binding capital constraint improves the pro.tability of the constrained bank, whereas the pro.tability of its unrestricted competitor declines. Especially, if an ine.cient bank chooses a strategy that might result in bankruptcy, capital requirements are welfare improving. However, also under conditions that both banks would also never default in the absence of regulation, mild capital requirements can be bene.cial as they stimulate banks to provide more loans. Too high requirements on the other hand relatively favour the ine.cient bank, and result in welfare losses.

Suggested Citation

  • Peter J.G. Vlaar, 2003. "On the Influence of capital Requirements on Competition and Risk taking in Banking," DNB Staff Reports (discontinued) 102, Netherlands Central Bank.
  • Handle: RePEc:dnb:staffs:102
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    File URL: https://www.dnb.nl/binaries/sr102_tcm46-146879.pdf
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    References listed on IDEAS

    as
    1. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
    2. Bhattacharya, Sudipto & Boot, Arnoud W A & Thakor, Anjan V, 1998. "The Economics of Bank Regulation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 745-770, November.
    3. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, May.
    4. Marshall, David A. & Prescott, Edward Simpson, 2001. "Bank capital regulation with and without state-contingent penalties," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 54(1), pages 139-184, June.
    5. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
    6. Arnoud Boot & Silva Dezõelan & Todd Milbourn, 1999. "Regulatory Distortions in a Competitive Financial Services Industry," Journal of Financial Services Research, Springer;Western Finance Association, vol. 16(2), pages 249-259, December.
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    Cited by:

    1. Imola Drigă & Codruța Dura & Ilie Răscolean, 2011. "Overview of the Caampl Early Warning System in Romanian Banking," Annals of the University of Petrosani, Economics, University of Petrosani, Romania, vol. 11(2), pages 71-80.
    2. Dura, Codruta & Driga, Imola, 2007. "Coordonatele auditului in marketingul financiar-bancar - situatia din Romania," MPRA Paper 3221, University Library of Munich, Germany.

    More about this item

    Keywords

    Cournot duopoly; Capital requirements; Pro?t paradox;

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure

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