The effectiveness of bank capital adequacy regulation: A theoretical and empirical approach

The aim of this paper is to analyse how banking firms set their capital ratios, that is, the rate of equity capital over assets. In order to study this issue, two theoretical models are developed. Both models demonstrate the existence of an optimal capital ratio; the first one for firms not affected by capital adequacy regulation, the second one for firms which are. The models have been tested by estimating a disequilibrium model using data from Spanish commercial banks. (C) 2003 Elsevier B.V. All rights reserved.