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Credit Market Competition and Capital Regulation

Author

Listed:
  • Franklin Allen
  • Elena Carletti
  • Robert Marquez

Abstract

It is commonly believed that equity finance for banks is more costly than deposits. This suggests that banks should economize on the use of equity and regulatory constraints on capital should be binding. Empirical evidence suggests that in fact this is not the case. Banks in many countries hold capital well in excess of regulatory minimums and do not change their holdings in response to regulatory changes. We present a simple model of bank moral hazard that is consistent with this observation. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to guarantee monitoring because it allows higher borrower surplus.

Suggested Citation

  • Franklin Allen & Elena Carletti & Robert Marquez, 2009. "Credit Market Competition and Capital Regulation," Economics Working Papers ECO2009/08, European University Institute.
  • Handle: RePEc:eui:euiwps:eco2009/08
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    credit market competition; monitoring; loan rates; capital; bank monitoring;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

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