Bank Capital Regulation and Incentives for Risk-Taking

52 Pages Posted: 19 Mar 2002

See all articles by Alistair Milne

Alistair Milne

Loughborough University - School of Business and Economics

A. Elizabeth Whalley

University of Warwick - Finance Group

Date Written: December 2001

Abstract

We analyse the incentive impact of bank capital regulation in a model with endogenous capital, assuming regulators randomly audit banks and require undercapitalised banks either to bear the fixed cost of new issue or to liquidate. Forward looking banks with sufficient franchise value maintain a buffer of capital in excess of the regulatory minimum. In our dynamic setting we show, amongst other results: that incentives for risk taking depend upon this buffer of free capital, not the total level; and that the regulatory capital requirement has no long run effect on bank risk-taking.

Keywords: capital dynamics, capital structure, charter value, franchise value, endogenous capital, financial distress, moral hazard, bank looting

JEL Classification: G21

Suggested Citation

Milne, Alistair K. L. and Whalley, A. Elizabeth, Bank Capital Regulation and Incentives for Risk-Taking (December 2001). Cass Business School Research Paper, WBS Finance Group Research Paper No. 17, Available at SSRN: https://ssrn.com/abstract=299319 or http://dx.doi.org/10.2139/ssrn.299319

Alistair K. L. Milne (Contact Author)

Loughborough University - School of Business and Economics ( email )

Epinal Way
Loughborough
Leicestershire, LE11 3TU
United Kingdom

A. Elizabeth Whalley

University of Warwick - Finance Group ( email )

Warwick Business School
University of Warwick
Coventry, CV4 7AL
Great Britain

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