Type: Working Paper
Credit Market Competition and Capital Regulation
Working Paper, EUI ECO, 2009/08
ALLEN, Franklin, CARLETTI, Elena, MARQUEZ, Robert, Credit Market Competition and Capital Regulation, EUI ECO, 2009/08 - http://hdl.handle.net/1814/10676
Retrieved from Cadmus, EUI Research Repository
It is commonly believed that equity finance for banks is more costly than deposits. This suggests that banks should economize on the use of equity and regulatory constraints on capital should be binding. Empirical evidence suggests that in fact this is not the case. Banks in many countries hold capital well in excess of regulatory minimums and do not change their holdings in response to regulatory changes. We present a simple model of bank moral hazard that is consistent with this observation. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to guarantee monitoring because it allows higher borrower surplus.
Cadmus permanent link: http://hdl.handle.net/1814/10676
Series/Number: EUI ECO; 2009/08