RISK-TAKING BEHAVIOUR UNDER BASEL CAPITAL REQUIREMENTS: WHAT IS THE IMPACT OF THE BANK MARKET POWER?

In this paper we study the effect on the bank risk-taking behaviour of the passage from the Basle 1 regulation framework to the Basle 2 one, this effect being different according to banks' market power. Our results show that the banks can adopt a pure prudent behaviour only if the capital adequacy ratio is risk based, as is the case of the Basle 2 capital regulation. These results differ according to banks' market power: only the banks with high market power make a prudent investment under Basle 2 if the return on risk asset is low. The increase in this return pushes these banks to change their behaviour and to invest only in risk project. Under these conditions, the effectiveness of the reform Basle 2 could be diminished, as more banks have a risk-taking behaviour.