Crises and Capital Requirements in Banking

30 Pages Posted: 26 May 2004

See all articles by Alan D. Morrison

Alan D. Morrison

University of Oxford - Said Business School; University of Oxford - Merton College

Lucy White

Centre for Economic Policy Research (CEPR); Boston University - Department of Finance & Economics

Multiple version iconThere are 3 versions of this paper

Date Written: April 2004

Abstract

We analyse a general equilibrium model in which there is both adverse selection of and moral hazard by banks. The regulator has several tools at their disposal to combat these problems. They can audit banks to learn their type prior to giving them a license, they can audit them ex post to learn the success probability of their projects and can impose capital adequacy requirements. When the regulator has a strong reputation for ex ante auditing, they use capital requirements to combat moral hazard problems. For less competent regulators, capital requirements can substitute for ex ante auditing ability. In this case, the banking system exhibits multiple equilibria so that crises of confidence in the banking system can occur only when the regulator's reputation is poor. Contrary to conventional wisdom, depending on regulator reputation, the appropriate policy response to a crisis of confidence may be to tighten capital requirements to improve the quality of surviving banks.

Keywords: Capital requirements, banking crises

JEL Classification: D51, D82, E58, G21

Suggested Citation

Morrison, Alan and White, Lucy, Crises and Capital Requirements in Banking (April 2004). CEPR Discussion Paper No. 4364. Available at SSRN: https://ssrn.com/abstract=551501

Alan Morrison

University of Oxford - Said Business School ( email )

Department of Finance
Park End Street
Oxford OX1 1HP
United Kingdom
+44 18 6527 6343 (Phone)
+44 18 6527 6310 (Fax)

University of Oxford - Merton College

Merton Street
Oxford OX1 4JD
United Kingdom
+44 18 6527 6343 (Phone)

Lucy White (Contact Author)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Boston University - Department of Finance & Economics ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

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