Bank Regulation and Market Discipline in the Presence of Risk-Shifting Incentives

46 Pages Posted: 26 Jul 2021 Last revised: 10 Aug 2021

See all articles by Suzanne Vissers

Suzanne Vissers

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Date Written: July 23, 2021

Abstract

This paper presents a bank capital structure model in which equity holders can increase asset risk once debt is in place. I study the effects of capital requirements and subsidized deposit insurance on the bank's privately optimal funding and operational risk level. The model predicts that there are synergetic effects of regulation and market discipline. When the regulator sets the capital charge and deposit insurance premium payments sufficiently high for a risky portfolio, the bank commits to the low-risk asset portfolio by setting a lower leverage ratio. This market discipline effect disappears when the regulatory costs become too high.

Keywords: Banking, Financial Regulation, Market Discipline, Optimal Capital Structure, Risk-Shifting

JEL Classification: G21, G28, G32, G33

Suggested Citation

Vissers, Suzanne, Bank Regulation and Market Discipline in the Presence of Risk-Shifting Incentives (July 23, 2021). Available at SSRN: https://ssrn.com/abstract=3892345 or http://dx.doi.org/10.2139/ssrn.3892345

Suzanne Vissers (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Chamberonne
Extranef 128
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://www.suzannevissers.com

Swiss Finance Institute

c/o University of Geneva
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Geneva 4, CH-1211
Switzerland

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