Voluntary Equity, Project Risk, and Capital Requirements

Andreas Haufler and Christoph Lülfesmann

No 357, Rationality and Competition Discussion Paper Series from CRC TRR 190 Rationality and Competition

Abstract: We introduce a model of the banking sector that formally incorporates a buffer function of capital. Heterogeneous banks choose their portfolio risk, bank size, and capital holdings. Banks voluntarily hold equity when the buffer effect against the risk of default outweighs the cost advantages of debt financing. In this setting, banks with lower monitoring costs are larger, choose riskier portfolios, and have less equity. Moreover, binding capital requirements or levies on bank borrowing are shown to make higher-risk portfolios more attractive. Accounting for banks' interior capital choices can thus explain why higher capital ratios incentivize banks to undertake riskier projects.

Keywords: voluntary equity; capital requirements; bank heterogeneity (search for similar items in EconPapers)
JEL-codes: G28 G38 H32 (search for similar items in EconPapers)
Date: 2022-12-27
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-ppm and nep-rmg
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Related works:
Working Paper: Voluntary Equity, Project Risk, and Capital Requirements (2023)
Working Paper: Voluntary Equity, Project Risk, and Capital Requirements (2022)
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