Competition Among Banks, Capital Requirements and International Spillovers

Abstract

The design of prudential bank capital requirements interacts with the industrial organization of the banking sector, in particular, with the level of competition among banks. Increased competition leads to excessive risk‐taking by banks which may have to be counteracted by tighter capital requirements. When capital requirements are internationally uniform but the levels of competition among banks in different countries are not, international spillovers arise on financial integration of these countries. This result begs a more careful analysis of the effect of financial liberalization on the stability of banking sectors in emerging countries. It also calls into question the merits of employing uniform capital requirements across countries that diverge in the industrial organization of their banking sectors.(J.E.L.: G21, G28, G38, F36, E58, D62)