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Capital Regulation, Heterogeneous Monitoring Costs, and Aggregate Loan Quality

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dc.contributor.author Kopecky, Kenneth
dc.contributor.author VanHoose, David D.
dc.date.copyright November 28, 2004
dc.identifier.uri http://hdl.handle.net/2104/325
dc.description.abstract This paper develops a banking-sector framework with heterogeneous loan monitoring costs. Banks are exposed to the moral hazard behavior of borrowers and endogenously choose whether to monitor their loans to eliminate this exposure. After analyzing an unregulated banking system, we examine several cases in which regulatory capital requirements bind the notional loan supplies of various subsets of banks. To gauge the impact of capital requirements, we define loan ‘quality’ in terms of either the ratio of monitored to total loans or the ratio of monitoring banks to total bank population. We find that binding capital requirements unambiguously increase the market loan rate and reduce aggregate lending, but, in all but one case, have an ambiguous effect loan ‘quality.’ Equally important, we show that capital requirements create a misallocation of monitoring activity within the banking system. These results suggest that the benefit/cost ratio of capital requirements is not necessarily greater than unity. en
dc.relation.ispartofseries BaylorBusiness Economics: Working Papers Series en
dc.relation.ispartofseries 2005-060-ECO en
dc.subject Bank Loans en
dc.subject JEL Classification: G28 en
dc.title Capital Regulation, Heterogeneous Monitoring Costs, and Aggregate Loan Quality en
dc.type Working Paper en


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