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Market Discipline, Capital Adequacy and Bank Behaviour: Theory and Indian Evidence

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  • Ghosh, Saibal
  • Das, Abhiman

Abstract

Policy debate with regard to financial intermediaries has focused on whether, and to what extent, governments should impose capital adequacy requirements on banks, or alternately, whether market forces could also ensure the stability of banking systems. The paper contributes to this debate by showing how market forces may motivate banks to select high capital adequacy ratios as a means of lowering their borrowing costs. If the effect of competition among banks is strong, then it may overcome the tendency for bank capitalisation that arises from systemic effects. If systemic effects are strong, regulation is required. Empirical tests for the Indian public sector banks during the 1990s demonstrate that better capitalised banks experienced lower borrowing costs. These findings suggest that ongoing reform efforts at the international level should primarily focus on increasing transparency and strengthening competition among banks.

Suggested Citation

  • Ghosh, Saibal & Das, Abhiman, 2005. "Market Discipline, Capital Adequacy and Bank Behaviour: Theory and Indian Evidence," MPRA Paper 17398, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:17398
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    References listed on IDEAS

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    1. Sergio L. Schmukler & Eduardo Levy-Yeyati & Maria Soledad Martinez Peria, 2004. "Market Discipline under Systemic Risk: Evidence from Bank Runs in Emerging Economies," Econometric Society 2004 Latin American Meetings 318, Econometric Society.
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    5. Miles, David, 1995. "Optimal regulation of deposit taking financial intermediaries," European Economic Review, Elsevier, vol. 39(7), pages 1365-1384, August.
    6. Benston, George J & Kaufman, George G, 1996. "The Appropriate Role of Bank Regulation," Economic Journal, Royal Economic Society, vol. 106(436), pages 688-697, May.
    7. Kevin Dowd, 2000. "Bank Capital Adequacy versus Deposit Insurance," Journal of Financial Services Research, Springer;Western Finance Association, vol. 17(1), pages 7-15, February.
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    9. María Soledad Martínez-Peria & Sergio Schmukler, 2002. "Do Depositors Punish Banks for Bad Behavior? Market Discipline, Deposit Insurance, and Banking Crises," Central Banking, Analysis, and Economic Policies Book Series,in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Se (ed.), Banking, Financial Integration, and International Crises, edition 1, volume 3, chapter 5, pages 143-174 Central Bank of Chile.
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    More about this item

    Keywords

    market disciplinel capital adequacy; deposit insurance; banking; India;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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