The Impact of Capital-Based Regulation on Bank Risk-Taking: A Dynamic Model
Posted: 19 May 1998
Date Written: March 1996
In this paper, we model the dynamic portfolio choice problem facing banks, calibrate the model using empirical data from the banking industry for 1984-1993, and assess quantitatively the impact of recent regulatory developments related to bank capital. The model suggests that two aspects of the new regulatory environment may have unintended effects: higher capital requirements may lead to increased portfolio risk, and capital-based premia do not deter risk-taking by well-capitalized banks. On the other hand, risk-based capital standards may have favorable effects provided the requirements are stringent enough.
JEL Classification: G21, G28
Suggested Citation: Suggested Citation