Banking on Regulations?
The financial crisis that erupted 2007-2008 has reinforced demand for regulation of banks. The Basle III accord which is to be implemented January first 2013 encompasses two types of regulations with the goal to enforce more prudence among banks. One is capital adequacy regulation which stipulates a lowest ratio between bank capital and bank assets. The other is constraints on dividends and bonuses payments. Banking on these regulations to raise prudence regarding risk taking among banks may lead to disappointment. Within a dynamic model of a value maximizing bank we find that both regulations lower bank value, also in situations where regulations do not bind. None of the regulations leads to increased optimal ratio between common equity and lending. Capital adequacy regulation reinforces credit squeeze when binding. More frequent dividend payouts leads to higher equilibrium bank capital.
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