Loan Monitoring, Competition, and Socially Optimal Bank Capital Regulations

J. OF RISK AND INSURANCE, Vol. 63 No. 2, June 1996

Posted: 29 Oct 1996

See all articles by Sumon C. Mazumdar

Sumon C. Mazumdar

Law and Economics Consulting Group (LECG), LLC; University of California, Berkeley - Haas School of Business

Suk Heun Yoon

Korea Institute of Finance

Abstract

This article analyzes socially optimal bank capital regulations that support fairly-priced deposit insurance. Under full information, banks voluntarily choose a socially optimal interior capital structure based on the cost-benefit tradeoff involved in monitoring loans. Capital regulations are, therefore, redundant. Under asymmetric information, incentive-compatible capital regulations together with fairly-priced deposit insurance are possible if and only if the regulator can prevent bank-borrower collusive side-payments and also observe the rate charged and the equity contributed by the bank for a loan. The bank would then again voluntarily choose the socially optimal interior capital structure and bank capital requirements would be redundant. Greater equity contributions by banks with higher loan quality are then socially optimal. These results highlight the critical importance of bank supervision in effective regulatory policy design.

JEL Classification: G21, G28, D8

Suggested Citation

Mazumdar, Sumon C. and Yoon, Suk Heun, Loan Monitoring, Competition, and Socially Optimal Bank Capital Regulations. J. OF RISK AND INSURANCE, Vol. 63 No. 2, June 1996, Available at SSRN: https://ssrn.com/abstract=7855

Sumon C. Mazumdar (Contact Author)

Law and Economics Consulting Group (LECG), LLC ( email )

2000 Powell Street, Suite 600
Emeryville, CA 94608
United States
510-450-5493 (Phone)

University of California, Berkeley - Haas School of Business

Finance Department
Berkeley, CA 94720
United States

Suk Heun Yoon

Korea Institute of Finance

4-1 Myung-dong 1-ga
Seoul 100-021
Korea

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
828
PlumX Metrics