Bank Capital Requirements and Managerial Self-Interest

28 Pages Posted: 30 Nov 1998

See all articles by Arturo Bris

Arturo Bris

IMD International; European Corporate Governance Institute (ECGI); Yale University - International Center for Finance

Salvatore Cantale

Tulane University - A.B. Freeman School of Business

Date Written: September 1998

Abstract

We analyze the effect of capital adequacy requirements on bank risk policy when managers and shareholders have different information about the quality of the loan portfolio. In a two-period model in which shareholders implement the optimal contract with managers, we show that the level of managerial effort (and therefore the quality of the loan portfolio) is higher when shareholders cannot observe the manager's action. When information regarding the bank loan portfolio is symmetric, capital requirements help reduce the excess risk-taking problem that deposit insurance creates. Taking as given optimal regulation on capital requirements and deposit insurance, we show that the moral hazard problem in banks leads to a reduction in the banks' loan portfolio through an increase in the managerial effort in loan supervision. Only high-quality loans are accepted by the bank, but some profitable investments are bypassed because managers are more interested in maximizing their compensation (diluting the stock value) than in maximizing the shareholders' wealth. Thus we conclude that the riskiness of banks may be suboptimally low under moral hazard. We show how bank debt can help alleviate this problem. Our results are related to the theoretical and empirical literature that deals with the effects of the Basle Accords on the banks' credit policy.

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JEL Classification: G21, K22, D82

Suggested Citation

Bris, Arturo and Cantale, Salvatore, Bank Capital Requirements and Managerial Self-Interest (September 1998). Yale School of Management IFC Working Paper. Available at SSRN: https://ssrn.com/abstract=139591 or http://dx.doi.org/10.2139/ssrn.139591

Arturo Bris (Contact Author)

IMD International ( email )

Ch. de Bellerive 23
P.O. Box 915
CH-1001 Lausanne
Switzerland

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Yale University - International Center for Finance ( email )

Box 208200
New Haven, CT 06520
United States

Salvatore Cantale

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States
504-865-5032 (Phone)
504-865-6751 (Fax)

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