Journal of Financial Services Research

, Volume 37, Issue 2, pp 131–158

Market Structure, Capital Regulation and Bank Risk Taking

Article

DOI: 10.1007/s10693-009-0054-y

Cite this article as:
Behr, P., Schmidt, R.H. & Xie, R. J Financ Serv Res (2010) 37: 131. doi:10.1007/s10693-009-0054-y

Abstract

This paper discusses the effect of capital regulation on the risk taking behavior of commercial banks. We first theoretically show that capital regulation works differently in different market structures of banking sectors. In lowly concentrated markets, capital regulation is effective in mitigating risk taking behavior because banks’ franchise values are low and banks have incentives to pursue risky strategies in order to increase their franchise values. If franchise values are high, on the other hand, the effect of capital regulation on bank risk taking is ambiguous. We then test the model predictions on a cross-country sample including 421 commercial banks from 61 countries. We find that capital regulation is effective in mitigating risk taking only in markets with a low degree of concentration. The results remain robust after accounting for financial sector development, legal system efficiency, and for other country and bank-specific characteristics.

Keywords

BanksMarket structureRisk shiftingFranchise valueCapital regulation

JEL Classification

G21G28

Copyright information

© Springer Science+Business Media, LLC 2009

Authors and Affiliations

  1. 1.Chair of International Banking and Finance, Department of FinanceGoethe-University FrankfurtFrankfurtGermany