Bank capital regulation, loan contracts, and corporate investment

Diemo Dietrich, Achim Hauck

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    Abstract

    This paper studies the link between bank capital regulation, bank loan contracts and the allocation of corporate resources across firms’ different business lines. Credit risk is lower when firms write contracts that oblige them to invest mainly into projects with highly tangible assets. We argue that firms have an incentive to choose a contract with overly safe and thus inefficient investments when intermediation costs are increasing in banks’ capital-to-asset ratio. Imposing minimum capital adequacy for banks can eliminate this incentive by putting a lower bound on financing costs.
    Original languageEnglish
    Pages (from-to)230-241
    JournalQuarterly Review of Economics and Finance
    Volume54
    Issue number2
    Early online date16 Oct 2013
    DOIs
    Publication statusPublished - May 2014

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