Can capital requirements induce private monitoring that is socially optimal?

Kenneth J. Kopecky and David VanHoose

Journal of Financial Stability, 2012, vol. 8, issue 4, 252-262

Abstract: This paper develops a framework for analyzing socially and privately optimal bank loan-monitoring decisions, with and without capital regulation. In contrast to the monitoring decision of a social planner who seeks to maximize the utility of aggregate consumption, banks choose to monitor only if doing so is consistent with maximizing the market value of equity. As a consequence, socially and privately optimal monitoring choices can diverge. Under some circumstances, appropriately configured capital regulation can bring private loan-monitoring decisions into line with those of the social planner. Nevertheless, the capital ratio required to attain this outcome hinges on a number of factors that are likely to be economy-specific, including the banking system's monitoring technology and its exposure to default. Thus, it is unlikely that a unique capital ratio will be able to induce socially optimal monitoring in all economies.

Keywords: Capital requirements; Monitoring; Social optimum (search for similar items in EconPapers)
JEL-codes: G28 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:8:y:2012:i:4:p:252-262

DOI: 10.1016/j.jfs.2012.02.001

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