Capital requirements and competition in banking industry
This paper focuses on the interaction between regulation and competition in an industrial organisation model. We analyze how capital requirements affect the profitability 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 effort to reduce loan losses so as to maximize profits. From the regulator's point of view, the free market solution is not optimal as private banks do not take in to account the consumer surplus and the social cost of bankruptcy (financial stability aspects). It is show that capital requirements may improve welfare, even under conditions that both banks would ever default. Moreover, we find that higher capital requirements impose a higher burden on the inefficient bank than on the efficient one, even though the requirement may only be binding for the efficient bank. If the inefficient bank chooses a strategy that might result in bankruptcy, capital requirements are particularly welfare improving.
|Date of creation:||2000|
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- Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
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Working Paper Series
WP-00-10, Federal Reserve Bank of Chicago.
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- 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.
- Bhattacharya, Sudipto & Boot, Arnoud W.A. & Thakor, Anjan V., 1995.
"The economics of bank regulation,"
DEE - Working Papers. Business Economics. WB
7082, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
- Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
- 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.
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