Carola Müller, Norges Bank (Job Market Seminar)

"Basel III capital requirements and heterogeneous banks"


I study how the interaction of competing minimum capital requirements affects the allocation of market shares across banks with different productivity. Regulators face a trade-off between the efficient allocation of resources and financial stability. In my model, banks’ productivity determines their optimal strategy in oligopolistic markets. Constrained only by a risk-weighted capital ratio, high-productivity banks specialize on a less risky strategy with higher leverage. Hence, they are directly affected when a leverage ratio is added. Considering a productivity-driven charter value renders capital requirements indirectly aiming at high-productivity banks less effective at a distortionary cost: In order to compensate the higher costs due to the additional requirement banks reduce their loan supply and interest rates rise. As a result, new entrants with productivity below the level of incumbent banks are attracted and thus average productivity in the banking market decreases.

Contact person: Peter Norman Sørensen