Economic and Regulatory Capital in Banking: What Is the Difference?
by Abel Elizaldea and Rafael Repullob
We analyze the determinants of regulatory capital (the minimum
required by regulation), economic capital (that chosen
by shareholders without regulation), and actual capital (that
chosen with regulation) in a dynamic model of a bank with a
loan-portfolio return described by the single-risk-factor model
of Basel II. We show that variables that only affect economic
capital, such as the intermediation margin and the cost of capital,
can account for large deviations from regulatory capital.
Actual capital is closer to regulatory capital, but the threat
of closing undercapitalized banks generates significant capital
buffers. Market discipline, proxied by the coverage of deposit
insurance, increases economic and actual capital, although the
effects are small.
JEL Codes: G21, G28.
(PDF, 32 pages 338 kb)
a CEMFI and UPNA
b CEMFI and CEPR