Banking Competition, Risk and Regulation

22 Pages Posted: 27 Dec 2004

See all articles by Wilko Bolt

Wilko Bolt

De Nederlandsche Bank (Dutch Central Bank); VU University Amsterdam

Alexander F. Tieman

International Monetary Fund (IMF)

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Abstract

In a dynamic framework, commercial banks compete for customers by setting acceptance criteria for granting loans, while taking into account regulatory requirements. By easing its acceptance criteria a bank faces a trade-off between attracting more demand for loans, thus making higher per-period profits, and deterioration in the quality of its loan portfolio, thus tolerating a higher risk of failure. Our main results state that more stringent capital adequacy requirements lead banks to set stricter acceptance criteria, and that increased competition in the banking industry leads to riskier bank behaviour. It is shown that risk-adjusted regulation is effective. In an extension of our basic model, we show that it may be beneficial for a bank to hold more equity than prescribed by the regulator, even though issuing equity is more expensive than attracting deposits.

Suggested Citation

Bolt, Wilko and Tieman, Alexander F., Banking Competition, Risk and Regulation. Scandinavian Journal of Economics, Vol. 106, No. 4, pp. 783-804, December 2004. Available at SSRN: https://ssrn.com/abstract=633437

Wilko Bolt (Contact Author)

De Nederlandsche Bank (Dutch Central Bank) ( email )

P.O. Box 98
1000 AB Amsterdam
Netherlands

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, ND North Holland 1081 HV
Netherlands

Alexander F. Tieman

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

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