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Why do banks hold capital in excess of regulatory requirements? A functional approach

Diemo Dietrich and Uwe Vollmer
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Uwe Vollmer: University of Leipzig

Finance from University Library of Munich, Germany

Abstract: This paper provides an explanation for the observation that banks hold on average a capital ratio in excess of regulatory requirements. We use a functional approach to banking based on Diamond and Rajan (2001) to demonstrate that banks can use capital ratios as a strategic tool for renegotiating loans with borrowers. As capital ratios affect the ability of banks to collect loans in a nonmonotonic way, a bank may be forced to exceed capital requirements. Moreover, high capital ratios may also constrain the amount a banker can borrow from investors. Consequently, the size of the banking sector may shrink.

JEL-codes: G21 G28 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-reg
Date: 2004-07-08
Note: Type of Document - pdf; pages: 23
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