Accounting for banks, capital regulation and risk-taking

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This paper examines risk-taking incentives in banks under dierent accounting regimes with capital regulation. In the model the bank’s decisions of capital issuance and investment policy are jointly determined. Given exogenous minimum capital requirement, the bank is more likely to issue equity capital in excess of the minimum required level and implement less risky investment policy under either lower-of-cost-ormarket accounting or fair value accounting than under historical cost accounting. But fair value accounting may induce more risk-taking compared to lower-of-cost-or-market accounting due to short term interest in the part of the bank. However, the disciplining role of lower-of-cost-or-market accounting may discourage bank’s incentive to exert project discovery eort