Credit Market Competition and Capital Regulation

Robert H. Smith School Research Paper No. RHS 06-37

Wharton Financial Institutions Center Working Paper No. 05-27

CFS Working Paper No. 2005/23

FEDS Working Paper No. 2006-11

EFA 2006 Zurich Meetings

62 Pages Posted: 9 Oct 2005 Last revised: 26 Jan 2014

Franklin Allen

Imperial College London

Elena Carletti

Bocconi University - Department of Finance; European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS)

Robert Marquez

University of California, Davis

Date Written: January 13, 2008

Abstract

It is commonly believed that equity finance for banks is more costly than deposits. This suggests that banks should economize on the use of equity and regulatory constraints on capital should be binding. Empirical evidence suggests that in fact this is not the case. Banks in many countries hold capital well in excess of regulatory minimums and do not change their holdings in response to regulatory changes. We present a simple model of bank moral hazard that is consistent with this observation. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to guarantee monitoring because it allows higher borrower surplus.

Suggested Citation

Allen, Franklin and Carletti, Elena and Marquez, Robert, Credit Market Competition and Capital Regulation (January 13, 2008). Robert H. Smith School Research Paper No. RHS 06-37; Wharton Financial Institutions Center Working Paper No. 05-27; CFS Working Paper No. 2005/23; FEDS Working Paper No. 2006-11; EFA 2006 Zurich Meetings. Available at SSRN: https://ssrn.com/abstract=813066 or http://dx.doi.org/10.2139/ssrn.813066

Franklin Allen (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Elena Carletti

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

Villa La Fonte, via delle Fontanelle 18
50016 San Domenico di Fiesole
Florence, Florence 50014
Italy

Robert S. Marquez

University of California, Davis ( email )

One Shields Avenue
Davis, CA 95616
United States

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