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Can capital requirements induce private monitoring that is socially optimal?

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  • Kopecky, Kenneth J.
  • VanHoose, David

Abstract

This paper develops a framework for analyzing socially and privately optimal bank loan-monitoring decisions, with and without capital regulation. In contrast to the monitoring decision of a social planner who seeks to maximize the utility of aggregate consumption, banks choose to monitor only if doing so is consistent with maximizing the market value of equity. As a consequence, socially and privately optimal monitoring choices can diverge. Under some circumstances, appropriately configured capital regulation can bring private loan-monitoring decisions into line with those of the social planner. Nevertheless, the capital ratio required to attain this outcome hinges on a number of factors that are likely to be economy-specific, including the banking system's monitoring technology and its exposure to default. Thus, it is unlikely that a unique capital ratio will be able to induce socially optimal monitoring in all economies.

Suggested Citation

  • Kopecky, Kenneth J. & VanHoose, David, 2012. "Can capital requirements induce private monitoring that is socially optimal?," Journal of Financial Stability, Elsevier, vol. 8(4), pages 252-262.
    • Handle: RePEc:eee:finsta:v:8:y:2012:i:4:p:252-262
    DOI: 10.1016/j.jfs.2012.02.001
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    References listed on IDEAS

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    More about this item

    Keywords

    Capital requirements; Monitoring; Social optimum;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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