We analyze the relationship between bank size and risk-taking under the Basel II Capital Accord. Using a model with imperfect competition and moral hazard, we show that the introduction of an internal ratings based (IRB) approach improves upon flat capital requirements if the approach is applied uniformly across banks and if the costs of implementation are not too high. However, the banks’ right to choose between the standardized and the IRB approaches under Basel II gives larger banks a competitive advantage and, due to fiercer competition, pushes smaller banks to take higher risks. This may even lead to higher aggregate risk-taking.

We analyze the reactions of stock returns and the spreads of credit default swaps (CDS) of banks from Europe and the USA to four major regulatory reforms in the aftermath of the subprime crisis, employing an event study analysis. Contrary to public perception, we find that financial markets indeed reacted to the structural reforms enacted at the national level. The reforms succeeded in reducing bail-out expectations relative to the post-bail-out period, especially for systemic banks. The strongest effects were found for the Dodd–Frank Act and in particular for the Volcker rule. Bank profitability was affected in all countries, showing up in lower equity returns.