Why do banks hold capital in excess of regulatory requirements? A functional approach
Diemo Dietrich and
No 192, IWH Discussion Papers from Halle Institute for Economic Research (IWH)
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.
Keywords: incomplete contracts; minimum capital requirements; bank capital; disintermediation; pro-cyclicality (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
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Working Paper: Why do banks hold capital in excess of regulatory requirements? A functional approach (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwhdps:iwh-192
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