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Theoretical Paradigm on Bank Capital Regulation and its Impact on Bank-Borrower Behavior

Author

Listed:
  • Gunakar Bhatta, Ph.D.

    (Nepal Rastra Bank)

Abstract

Bank equity plays an important role in the credit allocation process of financial intermediaries. Financial institutions with higher level of equity are in better position to absorb losses and repay deposits in a timely manner. This relates to the bank capital channel of monetary policy transmission mechanism stating that banks having sound financial health could contribute significantly in transmitting monetary impulses to the real sector. Considering the important role that bank equity plays in shaping the risk taking behavior of financial intermediaries, central banks set the minimum paid-up capital requirement for banks and financial institutions. Though this regulatory requirement is aimed at ensuring the smooth financial intermediation, this could become costlier in extending loans particularly in the times of business cycle fluctuations. A higher capital requirement might also constrain the lending capacity of a bank. Given the conflicting theoretical assumptions on the role of equity capital on financial stability and economic growth, this paper develops a theoretical model examining the relationship between bank equity and its effect on bank-borrower behavior. The theoretical model recommends that higher level of bank equity might be helpful in ensuring financial stability by altering the behavior of the bank and borrower.

Suggested Citation

  • Gunakar Bhatta, Ph.D., 2015. "Theoretical Paradigm on Bank Capital Regulation and its Impact on Bank-Borrower Behavior," NRB Economic Review, Nepal Rastra Bank, Economic Research Department, vol. 27(2), pages 19-34, October.
    • Handle: RePEc:nrb:journl:v:27:y:2015:i:2:p:2
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    References listed on IDEAS

    as
    1. Borio, Claudio & Zhu, Haibin, 2012. "Capital regulation, risk-taking and monetary policy: A missing link in the transmission mechanism?," Journal of Financial Stability, Elsevier, vol. 8(4), pages 236-251.
    2. Thakor, Anjan V. & Furlong Wilson, Patricia, 1995. "Capital requirements, loan renegotiation and the borrower's choice of financing source," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 693-711, June.
    3. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
    4. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
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    More about this item

    Keywords

    Bank; Credit; Capital; Regulation; Stability;
    All these keywords.

    JEL classification:

    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G00 - Financial Economics - - General - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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