The regulation of bank capital: Do capital standards promote bank safety?

David Besanko*, George Kanatas

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

123 Scopus citations

Abstract

We show that in an imperfect information environment the equity value of an impaired bank may increase or decrease when it is required to meet a capital standard. Regardless of the change in the bank's equity value, however, its stock price will fall in response to a forced recapitalization, consistent with recent empirical evidence. Simulations of our model suggest that this stock price decline is likely to be larger the smaller is the share of ownership held by the managers of the bank, also consistent with recent empirical evidence in the literature. Our model further predicts a rise in bank's non-interest expenses following a required recapitalization. Given the increase in the regulator's exposure that would accompany a reduction in the bank's market value of equity, the regulator may choose not to enforce the regulation. Hence, capital regulation may be time-inconsistent in this situation and consequently not have its intended risk-mitigating incentives.

Original languageEnglish (US)
Pages (from-to)160-183
Number of pages24
JournalJournal of Financial Intermediation
Volume5
Issue number2
DOIs
StatePublished - Apr 1996

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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