Optimal Bank Interest Margin, Capital Regulation and Deposit Insurance under a Cap Valuation

[[abstract]]This paper derives the bank’s optimal interest margin and relates it to the regulatory parameters under a cap valuation. This valuation helps the bank handle the volatilities so characteristic of lending markets. We find that the bank's interest margin is an increasing (decreasing) function of the capital-to-deposits ratio, the deposit insurance premium, and the actual number of days during the cap period if both the bank's marginal equity effect and the risk effect are positive (negative). The bank's optimal interest margin is an increasing (decreasing) function of the strike price if its marginal equity with expiration at the end of the period is negative (positive). Our findings demonstrate the important effects that regulatory parameters and cap pricing have on the bank's optimal interest margin