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Prudential Regulation and Capital Injection under Moral Hazard in Banks and Entrepreneurs

Author

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  • Hiroshi Osano

    (Institute of Economic Research, Kyoto University)

Abstract

This paper develops a model that considers the entrepreneur's moral hazard in the choice of project, the bank's moral hazard in the choice of bank loan contracting and refinancing, and the prudential regulation of the bank. The main findings are as follows: (i)Increasing capital requirements increases the probability of the safe project relative to that of the risky project, and increases (decreases) the probability of the risky project with refinancing relative to that of the risky project with liquidation if the refinancing requirement effect dominates the interest premium effect (if the interest premium effect dominates the refinancing requirement effect and the amount of capital injection is relatively small). (ii)Increasing repayments to the regulator increases the probability of the safe project and the probability of the risky project with liquidation relative to that of the risky project with refinanicng. (iii)Increasing the amount of capital injection decreases (increases) the probability of the safe project and the probability of the risky project with liquidation relative to that of the risky project with refinancing for a small (large) amount of capital injection.

Suggested Citation

  • Hiroshi Osano, 2003. "Prudential Regulation and Capital Injection under Moral Hazard in Banks and Entrepreneurs," KIER Working Papers 576, Kyoto University, Institute of Economic Research.
    • Handle: RePEc:kyo:wpaper:576
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    More about this item

    Keywords

    Prudential regulation; capital requirement; bank recapitalization; bank capital.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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