Credit Market Competition and Capital Regulation

Franklin Allen, Elena Carletti and Robert Marquez

No ECO2009/08, Economics Working Papers from European University Institute

Abstract: 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.

Keywords: credit market competition; monitoring; loan rates; capital; bank monitoring (search for similar items in EconPapers)
JEL-codes: G21 G31 D4 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-com, nep-cta and nep-reg
Date: 2009
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Related works:
Working Paper: Credit Market Competition and Capital Regulation (2005)
Working Paper: Credit market competition and capital regulation (2006)
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Persistent link: http://EconPapers.repec.org/RePEc:eui:euiwps:eco2009/08

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