Abstract

http://ssrn.com/abstract=1126108
 


 



The Effect of Capitalization on Bank Risk in the Presence of Regulatory and Managerial Moral Hazards


Thomas D. Jeitschko


Michigan State University - Department of Economics

Shin Dong Jeung


Financial Supervisory Services


The Icfai Journal of Bank Management, Vol. 12, No. 2, pp. 7-31, May 2008

Abstract:     
The conventional wisdom is that well-capitalized banks are less inclined to increase asset risk, because the option value of deposit insurance decreases with capitalization. There are, however, at least three shortcomings in the existing theories that cast doubt on the validity of the conventional wisdom. First, many studies neglect agency problems arising from the separation of management and ownership. Second, past studies rely on limited risk-return profiles of the asset choice set and do not consider profiles in which higher risk is associated with higher return. Finally, empirical studies on this issue provide only mixed evidence. The aim of this paper is to shed new light on this issue by expanding existing models to account for the shortcomings identified. Thus, it explicitly models three different incentives of the agents that shape the risk-taking behavior in banking, regulatory bodies, shareholders, and management. The paper considers how the respective incentives influence the riskiness of a bank portfolio for four distinct assumptions about the characteristics of risk-return profiles. As a result it is demonstrated that a bank's risk can either decrease or increase with capitalization. The paper empirically demonstrates the differences in risk-capitalization relationships across high and low capital banks and across publicly and non-publicly traded banks, indicating that risk-capitalization relationships are, indeed, sensitive to the relative forces of the three agents in determining asset risk.

Accepted Paper Series


Not Available For Download

Date posted: April 29, 2008 ; Last revised: January 9, 2014

Suggested Citation

Jeitschko, Thomas D. and Jeung, Shin Dong, The Effect of Capitalization on Bank Risk in the Presence of Regulatory and Managerial Moral Hazards. The Icfai Journal of Bank Management, Vol. 12, No. 2, pp. 7-31, May 2008. Available at SSRN: http://ssrn.com/abstract=1126108

Contact Information

Thomas D. Jeitschko (Contact Author)
Michigan State University - Department of Economics ( email )
110 Marshall-Adams Hall
East Lansing, MI 48824
United States
517-355-8302 (Phone)
517-432-1068 (Fax)
HOME PAGE: http://www.msu.edu/~jeitschk/
Shin Dong Jeung
Financial Supervisory Services ( email )
Seoul
Korea, Republic of (South Korea)
Feedback to SSRN


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