Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?
Kevin C. Murdock,
Thomas Hellmann () and
American Economic Review, 2000, vol. 90, issue 1, 147-165
In a dynamic model of moral hazard, competition can undermine prudent bank behavior. While capital-requirement regulation can induce prudent behavior, the policy yields Pareto-inefficient outcomes. Capital requirements reduce gambling incentives by putting bank equity at risk. However, they also have a perverse effect of harming banks' franchise values, thus encouraging gambling. Pareto-efficient outcomes can be achieved by adding deposit-rate controls as a regulatory instrument, since they facilitate prudent investment by increasing franchise values. Even if deposit-rate ceilings are not binding on the equilibrium path, they may be useful in deterring gambling off the equilibrium path.
JEL-codes: G21 G28 (search for similar items in EconPapers)
Note: DOI: 10.1257/aer.90.1.147
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