Best Instruments for Market Discipline in Banking

Greg Caldwell

Staff Working Papers from Bank of Canada

Abstract: The author develops a dynamic model of banking competition to determine which capital instrument is most effective in disciplining banks' risk choice. Comparisons are conducted between equity, subordinated debentures (SD), and uninsured deposits (UD) as funding sources. The model, adapted from Repullo (2004), analyzes the effectiveness of regulatory capital when banks incorporate charter value and competition for depositors into their risk-taking decision. The paper's main finding is that although all three instruments can induce market discipline on banks, equity weakly dominates SD and UD (with SD weakly dominating UD).

Keywords: Financial; institutions (search for similar items in EconPapers)
JEL-codes: G21 G28 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2007
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-com and nep-fmk
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Citations: View citations in EconPapers (3)

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