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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page The Impact of Capital-Based Regulation on Bank Risk-Taking: A Dynamic Model
Paul S. Calem and Rafael Rob

Abstract: In this paper, we model the dynamic portfolio choice problem facing banks, calibrate the model using empirical data from the banking industry for 1984-1993, and assess quantitatively the impact of recent regulatory developments related to bank capital. The model suggests that two aspects of the new regulatory environment may have unintended effects: higher capital requirements may lead to increased portfolio risk, and capital-based premia do not deter risk-taking by well-capitalized banks. On the other hand, risk-based capital standards may have favorable effects provided the requirements are stringent enough.

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Last update: July 16, 1997