Capital Levels and Risk-Taking Propensity in Financial Institutions
11 Pages Posted: 8 Jun 2013
Date Written: May 27, 2013
Regulators dedicate much attention to the option that financial institutions in distress have to transfer losses to their creditors. It is generally recognized that the existence of this option provides intermediaries with a powerful incentive to keep firm capital close to the minimal requirement. We argue that undercapitalization however harms profitable growth opportunities. Our model quantifies the interaction of these incentives and derives implications for regulation.
Keywords: risk propensity, net tangible value, default option, franchise value
JEL Classification: G31, G32, G18
Suggested Citation: Suggested Citation