The regulator’s trade-off: Bank supervision vs. minimum capital |
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Authors: | Florian Buck Eva Schliephake |
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Institution: | 1. Center for Economic Studies, Ludwig-Maximilians-University Munich, Schackstr. 4, 80539 Munich, Germany;2. Economics of Business and Law, Otto-von-Guericke University, Universitätsplatz 2, 39106 Magdeburg, Germany |
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Abstract: | We develop a simple model of banking regulation with two policy instruments: minimum capital requirements and the supervision of domestic banks. The regulator faces a trade-off: high capital requirements cause a drop in the banks’ profitability, whereas strict supervision reduces the scope of intermediation and is costly for taxpayers. We show that a mix of both instruments minimises the costs of preventing the collapse of financial intermediation. Once we allow for cross-border banking, the optimal policy is not feasible. If domestic supervisory effort is not observable, our model predicts a race to the bottom in capital requirement regulation. Therefore, countries are better off by harmonising regulation on an international standard. |
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Keywords: | F53 G21 G28 |
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