Bank Capitalization as a Signal
26 Pages Posted: 27 Aug 2012
Date Written: May 2012
Abstract
The level of a bank‘s capitalization can effectively transmit information about its riskiness and therefore support market discipline, but asymmetry information may induce exaggerated or distortionary behavior: banks may vie with one another to signal confidence in their prospects by keeping capitalization low, and banks‘ creditors often cannot distinguish among them - tendencies that can be seen across banks and across time. Prudential policy is warranted to help offset these tendencies.
Keywords: Banks, Economic models, probability, equation, bank capitalization, probability of default, present value, banking, equations, functional forms, random variable, dividend policy, probabilities, financial strength, banking sector, tier 1 capital, bank of england, banking business, markov process, bank capital, integral, random component, bank value, mathematica, bankrupt, cumulative distribution function
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