Working Paper: CEPR ID: DP3721
Authors: Rafael Repullo
Abstract: This Paper presents a dynamic model of imperfect competition in banking where banks can invest in a prudent or a gambling asset. We show that if intermediation margins are small, the banks? franchise values will be small, and in the absence of regulation only a gambling equilibrium will exist. In this case, either flat-rate capital requirements or binding deposit rate ceilings can ensure the existence of a prudent equilibrium, although both have a negative impact on deposit rates. Such impact does not obtain with either risk-based capital requirements or non-binding deposit rate ceilings, but only the former are always effective in controlling risk-shifting incentives.
Keywords: bank regulation; capital requirements; deposit rate ceilings; franchise values; imperfect competition; moral hazard; risk-shifting
JEL Codes: D43; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| capital requirements (G32) | banks' incentives to engage in prudent versus gambling investments (G21) |
| higher capital requirements (G28) | reduce banks' franchise values (G28) |
| reduce banks' franchise values (G28) | influences their risk-taking decisions (D91) |
| low intermediation margins (G21) | increased risk-taking behavior (D91) |
| flat-rate capital requirements (G28) | existence of a prudent equilibrium (C62) |
| binding deposit rate ceilings (E43) | existence of a prudent equilibrium (C62) |
| risk-based capital requirements (G28) | controlling risk-shifting incentives (G38) |
| deposit rate ceilings (E43) | ensure prudent behavior (D18) |