Market structure, capital regulation and bank risk taking

Patrick Behr, Reinhard H. Schmidt, Ru Xie

Research output: Contribution to journalArticlepeer-review

35 Citations (Scopus)

Abstract

This paper discusses the effect of capital regulation on the risk taking behavior of commercial banks. We first theoretically show that capital regulation works differently in different market structures of banking sectors. In lowly concentrated markets, capital regulation is effective in mitigating risk taking behavior because banks' franchise values are low and banks have incentives to pursue risky strategies in order to increase their franchise values. If franchise values are high, on the other hand, the effect of capital regulation on bank risk taking is ambiguous. We then test the model predictions on a cross-country sample including 421 commercial banks from 61 countries. We find that capital regulation is effective in mitigating risk taking only in markets with a low degree of concentration. The results remain robust after accounting for financial sector development, legal system efficiency, and for other country and bank-specific characteristics.

Original languageEnglish
Pages (from-to)131-158
Number of pages28
JournalJournal of Financial Services Research
Volume37
Issue number2-3
Early online date6 Mar 2009
DOIs
Publication statusPublished - 1 Jun 2010

Keywords

  • Banks
  • Capital regulation
  • Franchise value
  • Market structure
  • Risk shifting

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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