Closure Rules, Market Power and Risk-Taking in a Dynamic Model of Bank Behaviour

LSE Paper 196

Posted: 25 Jul 1998

See all articles by Javier Suarez

Javier Suarez

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: November 1994

Abstract

The value of bank charters is an important component of bankruptcy costs to bankers and may constitute an incentive for banks to adopt prudent decisions. Charter values had been considered as exogenous by previous researchers. Dynamic programming techniques allow us to obtain simultaneously the (endogenous) value of a bank and its optimal investment and financial policies. This model predicts a bang-bang risk-taking behaviour by banks which might explain the sudden appearance of solvency problems in the banking sector. Soft prudential regulation, low market power and a high risk-free interest rate may shift a bank from safe to risky. So, capital and asset regulations, and entry and closure rules are alternative ways to preserve solvency. Policy implications for the regulatory debate in the US and Europe are derived.

JEL Classification: G21

Suggested Citation

Suarez, Javier, Closure Rules, Market Power and Risk-Taking in a Dynamic Model of Bank Behaviour (November 1994 ). LSE Paper 196, Available at SSRN: https://ssrn.com/abstract=6930

Javier Suarez (Contact Author)

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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