A theoretical analysis of alternative approaches to financial regulation

Francesco M. Paris

European Financial Management, 2000, vol. 6, issue 1, 19-40

Abstract: This paper studies alternative regulatory approaches within the framework of intermediaries’ capital requirements, one of the cornerstones of modern financial regulation. The basic assumptions are that the intermediary’s capital is valued as a down‐and‐out call option written on its own assets and that the optimal capital requirement is the one minimizing the total expected social costs. The analysis discusses the total expected costs’ function within three alternative regulatory contexts and allows for a comparison of alternative approaches formalized by a set of five fundamental propositions explaining the impact of the regulatory choice on critical aspects such as the intermediary’s capital size and riskiness, his/her assets’ choice, the competition among either different intermediaries or different functions and, last but not least, the intermediary’s operational structure.

Date: 2000
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