1 Intertemporal effects of capital requirements on risk taking behavior of banks

This paper analyses the impact of regulatory capital requirements on the risk taking behavior of value maximizing banks using a dynamic financial intermediation model. It investigates several cases of intertemporal effects of capital regulation on risk choices when banks face different regulatory conditions. The results reveal differences in a bank’s risk taking behavior based on profit, multiplier, and leverage effects. The relationships between retention rate, discount factor, and risky asset return have important implications for first and/or second best regulation. Optimal regulatory rules are derived for different scenarios. JEL classification: G21; G2