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Why do banks hold capital in excess of regulatory requirements? A functional approach

Author

Listed:
  • Diemo Dietrich

    (Halle Institute for Economic Research)

  • Uwe Vollmer

    (University of Leipzig)

Abstract

This paper provides an explanation for the observation that banks hold on average a capital ratio in excess of regulatory requirements. We use a functional approach to banking based on Diamond and Rajan (2001) to demonstrate that banks can use capital ratios as a strategic tool for renegotiating loans with borrowers. As capital ratios affect the ability of banks to collect loans in a nonmonotonic way, a bank may be forced to exceed capital requirements. Moreover, high capital ratios may also constrain the amount a banker can borrow from investors. Consequently, the size of the banking sector may shrink.

Suggested Citation

  • Diemo Dietrich & Uwe Vollmer, 2004. "Why do banks hold capital in excess of regulatory requirements? A functional approach," Finance 0407006, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0407006
    Note: Type of Document - pdf; pages: 23
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    References listed on IDEAS

    as
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    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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