Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?

Hellmann, Thomas, Murdock, Kevin and Stiglitz, Joseph (2000) Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough? American Economic Review, 90 (1). pp. 147-165.

Abstract

In a dynamic model of moral hazard, competition can undermine prudent bank behavior. While capital-requirement regulation can induce prudent behavior, the policy yields Pareto-inefficient outcomes. Capital requirements reduce gambling incentives by putting bank equity at risk. However, they also have a perverse effect of harming banks' franchise values, thus encouraging gambling. Pareto-efficient outcomes can be achieved by adding deposit-rate controls as a regulatory instrument, since they facilitate prudent investment by increasing franchise values. Even if deposit-rate ceilings are not binding on the equilibrium path, they may be useful in deterring gambling off the equilibrium path.

Item Type: Article
Keywords: bank regulation
Subject(s): Finance
Centre: Faculty of Finance
Date Deposited: 01 May 2015 11:15
Last Modified: 23 Oct 2015 14:08
URI: http://eureka.sbs.ox.ac.uk/id/eprint/5304

Actions (login required)

Edit View Edit View