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Why do Banks Hold Capital in Excess of Regulatory Requirements? A Functional Approach

Lookup NU author(s): Dr Diemo DietrichORCiD

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Abstract

This paper provides an explanation for the observation that banks hold on average a capital ratio in excess of regulatory requirements. We use a functional approach to banking based on Diamond and Rajan (2001) to demonstrate that banks can use capital ratios as a strategic tool for renegotiating loans with borrowers. As capital ratios affect the ability of banks to collect loans in a nonmonotonic way, a bank may be forced to exceed capital requirements. Moreover, high capital ratios may also constrain the amount a banker can borrow from investors. Consequently, the size of the banking sector may shrink.

Publication metadata

Author(s): Dietrich D, Vollmer U

Publication type: Article

Publication status: Published

Journal: DBW-Die Betriebswirtschaft

Year: 2007

Volume: 67

Issue: 2

Pages: 153-166

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