Effect of Bank Capital Requirements on Bank Risk-taking and Financial Stability

Abstract

This paper reviews theoretical and empirical studies on the way that capital requirements influences bank capital structure, risk-taking and lending. Deposit insurance, when not fairly priced, give incentives for excessive risk-taking. To alleviate this problem regulator found as necessary the use of certain requirements such as capital requirement. Based on this, it is obligatory for banks to hold more capital that means to have more of their own funds at risk. The theoretical literature related to the way how capital regulation influences banks on their decision for the capital structure and portfolio risk says more than that. Capital requirements were supposed to enhance financial stability and economic growth. Regarding economic growth, the effects of capital requirements can influence it directly or indirectly. Changes that capital requirements bring to the credit supply, costs of capital and to the bank asset risks affect indirectly the economic growth. Higher capital requirements reduce credit supply and decreases credit demand which in turn may slow down economic growth. Nevertheless, well-capitalized banks make provision of credit more consistent and enhance financial stability. Suggestions given from the theoretical literature and lessons learned from empirical researches are going to be used in analyzing effects of bank capital requirements on the relation between efficiency, capital and risk-taking in Albanian banking system

DOI: 10.5901/mjss.2016.v7n1p340