Abstract
In this paper, we investigate how the solvency regulation of a bank affects resource allocation and welfare. We show that a banker’s expected profit always decreases due to the solvency regulation, and more importantly, each depositor’s expected utility is not necessarily improved by the solvency regulation in general. We also investigate how allocative efficiency measured by Kaldor criteria changes due to the solvency regulation, and show that the regulation increases the efficiency measured by this criteria if and only if the total amount of investment in a project increases in the economy.
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