Economic and Regulatory Capital in Banking: What Is the Difference?

Abel Elizalde and Rafael Repullo
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Abel Elizalde: CEMFI and UPNA

International Journal of Central Banking, 2007, vol. 3, issue 3, 87-117

Abstract: We analyze the determinants of regulatory capital (the minimum required by regulation), economic capital (that chosen by shareholders without regulation), and actual capital (that chosen with regulation) in a dynamic model of a bank with a loan-portfolio return described by the single-risk-factor model of Basel II. We show that variables that only affect economic capital, such as the intermediation margin and the cost of capital, can account for large deviations from regulatory capital. Actual capital is closer to regulatory capital, but the threat of closing undercapitalized banks generates significant capital buffers. Market discipline, proxied by the coverage of deposit insurance, increases economic and actual capital, although the effects are small.

JEL-codes: G21 G28 (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (36)

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Persistent link: https://EconPapers.repec.org/RePEc:ijc:ijcjou:y:2007:q:3:a:3

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