The Role of Capital Adequacy Requirements in Sound Banking Systems

41 Pages Posted: 2 Jun 2001

See all articles by Alan D. Morrison

Alan D. Morrison

University of Oxford - Said Business School; University of Oxford - Merton College

Lucy White

Centre for Economic Policy Research (CEPR); Boston University - Department of Finance & Economics

Date Written: March 2001

Abstract

We analyse a general equilibrium model in which there is both adverse selection of and moral hazard by banks. The regulator has two tools at her disposal - she can audit banks to learn their type prior to giving them a licence, and she can impose capital adequacy requirements. When the regulator has a strong reputation for screening she uses capital requirements to combat moral hazard problems. For less competent regulators, capital requirements substitute for screening ability. In this case the banking system exhibits multiple equilibria so that crises of confidence in the banking system can occur. We also show that in either case, a system of deposit insurance funded through general taxation will be welfare-improving and will allow capital requirements to be eased.

Keywords: Capital adequacy, bank regulation, deposit insurance, moral hazard, screening, signalling, adverse selection.

JEL Classification: G21, G28

Suggested Citation

Morrison, Alan and White, Lucy, The Role of Capital Adequacy Requirements in Sound Banking Systems (March 2001). Available at SSRN: https://ssrn.com/abstract=270728 or http://dx.doi.org/10.2139/ssrn.270728

Alan Morrison (Contact Author)

University of Oxford - Said Business School ( email )

Department of Finance
Park End Street
Oxford OX1 1HP
United Kingdom
+44 18 6527 6343 (Phone)
+44 18 6527 6310 (Fax)

University of Oxford - Merton College

Merton Street
Oxford OX1 4JD
United Kingdom
+44 18 6527 6343 (Phone)

Lucy White

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

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