Estimation Error in Regulatory Capital Requirements: Theoretical Implications for Consumer Bank Profitability

Despite the topic's societal importance and despite progress in bank research, a lack of consensus exists concerning either the desirability of bank regulation or its optimal design. Enforcement of minimum bank capital standards has been shown to enhance bank stability, but also serves as a pot...

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Bibliographic Details
Published in:The Journal of the Operational Research Society 2010-03, Vol.61 (3), p.381-392
Main Authors: Beling, P., Overstreet, G., Rajaratnam, K.
Format: Article
Language:English
Subjects:
Applied sciences
Bank capital
Bank loans
Banking industry
Banking regulation
Banks
Basel Accord
Business and Management
Capital requirements
Commercial regulation
Consumer credit
Credit risk
Economic profit
Economic regulation
Equity
Exact sciences and technology
International banking
Liquidity
Management
Operational research and scientific management
Operational research. Management science
Operations research
Operations Research/Decision Theory
Parameter estimation
Part 1: Consumer Credit Risk Modelling
Part I: Consumer Credit Risk Modeling
Portfolio theory
Profitability
Regulation of financial institutions
Retail banking
Studies
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Summary:Despite the topic's societal importance and despite progress in bank research, a lack of consensus exists concerning either the desirability of bank regulation or its optimal design. Enforcement of minimum bank capital standards has been shown to enhance bank stability, but also serves as a potential source of incremental costs, some of which are subtle. Such widely ambiguous research results point to the need for theoretical research regarding capital regulation across diverse banking systems. Along the latter lines, consumer bank issues have been generally neglected. This paper theoretically examines the performance implications of misestimating the regulatory capital requirement for a stylised consumer bank. For our stylised consumer bank, we prove that misestimation, irrespective of its direction, results in lower economic profits and, hence, value. Conclusions and implications for future work are drawn.
ISSN:0160-5682
1476-9360
DOI:10.1057/jors.2009.109