Bank Capital and Risk Taking
Bank of England Working Paper No. 90
44 Pages Posted: 22 Feb 1999
Date Written: 1998
Abstract
Bank risk-taking and capitalisation is studied in a continuous time model with a closed form solution, assuming uncertain cash flow, random regulatory audit, and a constraint on equity issue. Capital reserves are built up towards a desired level as an insurance against the threat of liquidation. Risk-taking is a discontinuous function of the level of capital. A solution is derived for the liquidation rate in steady state and the determinants of charter value are investigated. Minimum capital standards are found to have little long-term impact on bank behaviour. Audit frequency is the principal tool for restraining moral hazard.
JEL Classification: G21
Suggested Citation: Suggested Citation
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