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Risk in Banking and Capital Regulation
Author(s) -
KIM DAESIK,
SANTOMERO ANTHONY M.
Publication year - 1988
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1988.tb03966.x
Subject(s) - capital adequacy ratio , capital requirement , economic capital , capital (architecture) , minimum capital , risk adjusted return on capital , bank regulation , deposit insurance , business , asset (computer security) , portfolio , monetary economics , cost of capital , economics , actuarial science , finance , financial capital , microeconomics , capital formation , computer science , profit (economics) , computer security , archaeology , incentive , history
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.