Finance Papers

Document Type

Journal Article

Date of this Version

2011

Publication Source

Review of Financial Studies

Volume

24

Issue

4

Start Page

983

Last Page

1018

DOI

10.1093/rfs/hhp089

Abstract

Empirical evidence suggests that banks hold capital in excess of regulatory minimums. This did not prevent the financial crisis and underlines the importance of understanding bank capital determination. Market discipline is one of the forces that induces banks to hold positive capital. The literature has focused on the liability side. We develop a simple theory based on monitoring to show that discipline from the asset side can also be important. In perfectly competitive markets, banks can find it optimal to use costly capital rather than the interest rate on the loan to commit to monitoring because it allows higher borrower surplus.

Copyright/Permission Statement

This is a pre-copyedited, author-produced PDF of an article accepted for publication in Review of Financial Studies following peer review. The version of record is available online at: http://dx.doi.org/10.1093/rfs/hhp089.

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Date Posted: 27 November 2017

This document has been peer reviewed.