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Banking Competition, Risk, and Regulation

  • Alexander F. Tieman
  • Wilko Bolt

In a dynamic theoretical framework, commercial banks compete for customers by setting acceptance criteria for granting loans, taking regulatory requirements into account. By easing its acceptance criteria a bank faces a trade-off between attracting more demand for loans, thus making higher per period profits, and a deterioration of the quality of its loan portfolio, thus tolerating a higher risk of failure. Our main results state that more stringent capital adequacy requirements lead banks to set stricter acceptance criteria, and that increased competition in the banking industry leads to riskier bank behavior. In an extension of our basic model, we show that it may be beneficial for a bank to hold more equity than prescribed by the regulator, even though holding equity is more expensive than attracting deposits.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 04/11.

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Length: 26
Date of creation: 01 Jan 2004
Date of revision:
Handle: RePEc:imf:imfwpa:04/11
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  1. P.J.G. Vlaar, 2000. "Capital requirements and competition in the banking industry," WO Research Memoranda (discontinued) 634, Netherlands Central Bank, Research Department.
  2. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers 9516, Centro de Estudios Monetarios Y Financieros-.
  3. Joe Peek & Eric Rosengren, 1991. "The capital crunch: neither a borrower nor a lender be," Working Papers 91-4, Federal Reserve Bank of Boston.
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  7. Chu, Kam Hon, 1999. "Free Banking and Information Asymmetry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 31(4), pages 748-62, November.
  8. Skander Van den Heuvel, 2006. "The Bank Capital Channel of Monetary Policy," 2006 Meeting Papers 512, Society for Economic Dynamics.
  9. Petersen, Mitchell A & Rajan, Raghuram G, 1995. "The Effect of Credit Market Competition on Lending Relationships," The Quarterly Journal of Economics, MIT Press, vol. 110(2), pages 407-43, May.
  10. Jokivuolle, Esa & Kauko, Karlo, 2001. "The New Basel Accord: some potential implications of the new standards for credit risk," Research Discussion Papers 2/2001, Bank of Finland.
  11. Stephen F. LeRoy, 1990. "Mutual deposit insurance," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue jun8.
  12. Matutes, Carmen & Vives, Xavier, 2000. "Imperfect competition, risk taking, and regulation in banking," European Economic Review, Elsevier, vol. 44(1), pages 1-34, January.
  13. Peter J.G. Vlaar, 2000. "Capital requirements and competition in banking industry," Working Paper Series WP-00-18, Federal Reserve Bank of Chicago.
  14. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, August.
  15. C. H. Furfine, 2000. "Evidence on the response of US banks to changes in capital requirements," BIS Working Papers 88, Bank for International Settlements.
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