Capital Regulation and Competition as a Moderator for Banking Stability

Capital regulation forces banks to fund a substantial amount of their investments with equity. This creates a buffer against losses but also increases the cost of funding. If higher funding costs translate into higher loan interest rates, the bank's assets are also likely to become more risky,...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 2016-12, Vol.48 (8), p.1787-1814
Main Author: SCHLIEPHAKE, EVA
Format: Article
Language:English
Subjects:
Bank portfolios
Banking
banking competition
capital regulation
Capital requirements
Competition between banks
Equity
financial stability
G21
K23
L13
Regulation of financial institutions
Risk management
Studies
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Summary:Capital regulation forces banks to fund a substantial amount of their investments with equity. This creates a buffer against losses but also increases the cost of funding. If higher funding costs translate into higher loan interest rates, the bank's assets are also likely to become more risky, which may destabilize the lending bank. This paper argues that the level of competition in the banking sector can determine whether the buffer or cost effect prevails. The endogenous level of competition may be crucial in determining the efficiency of capital regulation in undercapitalized banking sectors, with excess capacities and correlated risks.
ISSN:0022-2879
1538-4616
DOI:10.1111/jmcb.12371