Capital Regulation, Bank Behavior, and Market Structure

Abstract

In light of five decades of regulatory effort based at least in part on minimum capital requirements, one might anticipate that a perusal of the academic banking literature would yield considerable agreement that capital requirements are a worthy tool within a bank regulator’s arsenal. In fact, the theoretical banking literature is sharply divided concerning the effects of capital requirements on bank behavior and, hence, on the risks faced by individual institutions and the banking system as a whole. Some academic work indicates that capital requirements unambiguously contribute to various possible measures of bank stability. In contrast, other work concludes that if anything, capital requirements make banks riskier institutions than they would be in the absence of such requirements. This chapter reviews these various perspectives on the effects of bank capital regulation.