This paper investigates the role of bank capital regulation in risk control. It is known that banks choose portfolios of higher risk because of inefficiently priced deposit insurance. Bank capital regulation is a way to redress this bias toward risk. Utilizing the mean‐variance model, the following results are shown: (a) the use of simple capital ratios in regulation is an ineffective means to bound the insolvency risk of banks; (b) as a solution to problems of the capital ratio regulation, the “theoretically correct” risk weights under the risk‐based capital plan are explicitly derived; and (c) the “theoretically correct” risk weights are restrictions on asset composition, which alters the optimal portfolio choice of banking firms

The authors examine the optimal design of a risk-adjusted deposit insurance scheme when the regulator has less information than the bank about the inherent risk of the bank's assets (adverse selection) and when the regulator is unable to monitor the extent to which bank resources are being directed away from normal operations toward activities that lower asset quality (moral hazard). Under a socially optimal insurance scheme: (1) asset quality is below the first-best level, (2) higher-quality banks have larger asset bases and face lower capital adequacy requirements than lower-quality banks, and (3) the probability of failure is equated across banks

We examine the optimal design of a risk‐adjusted deposit insurance scheme when the regulator has less information than the bank about the inherent risk of the bank's assets (adverse selection), and when the regulator is unable to monitor the extent to which bank resources are being directed away from normal operations toward activities that lower asset quality (moral hazard). Under a socially optimal insurance scheme: (1) asset quality is below the first‐best level, (2) higher‐quality banks have larger asset bases and face lower capital adequacy requirements than lower‐quality banks, and (3) the probability of failure is equated across banks

Using loan‐level data from Germany, we investigate how the introduction of model‐based capital regulation affected banks' ability to absorb shocks. The objective of this regulation was to enhance financial stability by making capital requirements responsive to asset risk. Our evidence suggests that banks “optimized” model‐based regulation to lower their capital requirements. Banks systematically underreported risk, with underreporting more pronounced for banks with higher gains from it. Moreover, large banks benefitted from the regulation at the expense of smaller banks. Overall, our results suggest that sophisticated rules may have undesired effects if strategic misbehavior is difficult to detect

To explain the evolution of U.S. deposit institutions and markets in the 1960sand 1970s, we feed into the regulatory dialectic assumptions about the objectives of federal banking regulation and about outside forces that disturb the adjustment process. The disturbing exogenous forces are accelerating change in the technological and market environment of commercial banking and increasing uncertainty concerning the future speed of enviromental change. We hypothesize that, in the face of these environmental changes, the adaptive efficiency shown on average by deposit-institution managers is greater than that shown by managers of the several competing banking agencies. Incorporating this differential adaptive capacity into the regulatory dialectic helps us to understand how increases in the pace of environmental change and in the degree of environmental uncertainty led regulatee responses to come more quickly and regulatory responses to come more slowly. The bottom line is that, when the environment changes rapidly and becomes more uncertain, traditional forms of U.S. banking regulation can be overwhelmed by technological and regulation-induced innovation

Lucille S. Mayne, Session Topic: Trends in Banking Structure and Regulation: Discussion, The Journal of Finance, Vol. 26, No. 2, Papers and Proceedings of the Twenty-Ninth Annual Meeting of the American Finance Association Detroit, Michigan December 28-30, 1970 (May, 1971), pp. 647-649

Charles Schotta, Session Topic: Trends in Banking Structure and Regulation: Discussion, The Journal of Finance, Vol. 26, No. 2, Papers and Proceedings of the Twenty-Ninth Annual Meeting of the American Finance Association Detroit, Michigan December 28-30, 1970 (May, 1971), pp. 650-651

The effectiveness of bank capital adequacy requirements is examined in this paper. Using empirical tests similar to those employed by Peltzman and Mingo, no significant relationship is found between changes in bank capital and the capital standards imposed by regulators. The findings conflict with those of previous studies. The conflict in findings, it is argued, results from the failure of previous studies to account for the effect of binding deposit rate ceilings

The effectiveness of bank capital adequacy requirements is examined in this paper. Using empirical tests similar to those employed by Peltzman and Mingo, no significant relationship is found between changes in bank capital and the capital standards imposed by regulators. The findings conflict with those of previous studies. The conflict in findings, it is argued, results from the failure of previous studies to account for the effect of binding deposit rate ceilings

James L. Bicksler, Session Topic: Studies in the Economics of Bank Regulation: Discussion, The Journal of Finance, Vol. 31, No. 2, Papers and Proceedings of the Thirty-Fourth Annual Meeting of the American Finance Association Dallas, Texas December 28-30, 1975 (May, 1976), pp. 252-255