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When Banks Strategically React to Regulation: Market Concentration as a Moderator for Stability

Author

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  • Eva Schliephake

    (Faculty of Economics and Management, Otto-von-Guericke University Magdeburg)

Abstract

Minimum capital requirement regulation forces banks to refund a substantial amount of their investments with equity. This creates a buffer against losses, but also increases the cost of funding. If higher refunding costs translate into higher loan interest rates, then borrowers are likely to become more risky, which may destabilize the lending bank. This paper argues that, in addition to the buffer and cost effect of capital regulation, there is a strategic effect. A binding capital requirement regulation restricts the lending capacity of banks, and therefore reduces the intensity of loan interest rate competition and increases the banks' price setting power as shown in Schliephake and Kirstein (2013). This paper discusses the impact of this indirect effect from capital regulation on the stability of the banking sector. It is shown that the enhanced price setting power can reverse the net effect that capital requirements have under perfect competition.

Suggested Citation

  • Eva Schliephake, 2013. "When Banks Strategically React to Regulation: Market Concentration as a Moderator for Stability," FEMM Working Papers 130012, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
  • Handle: RePEc:mag:wpaper:130012
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    References listed on IDEAS

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    More about this item

    Keywords

    Capital Requirement Regulation; Competition; Financial Stabilityt;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • K23 - Law and Economics - - Regulation and Business Law - - - Regulated Industries and Administrative Law
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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