Optimal Bank Capital Requirements: An Asymmetric Information Perspective

The issue on the amount of capital banks should hold has pushed back the debate on top of policymakers’ agenda. Literature on this field mainly focuses on how to prevent banks from gaming risk-weighted capital requirements. The analysis has provided differ-ent types of solutions, such as the introduction of penalties and complementary use of risk-sensitive capital requirements and leverage ratio. Although the majority of theoreti-cal papers rely on an asymmetric information framework, only one source of asymmetry is taken into account. The paper fills this gap by studying how to implement a socially optimal regulation scheme that simultaneously faces moral hazard and adverse selection problems. Including both sources of asymmetry is crucial because of the supervisor’s in-ability to distinguish between risk profiles and misconduct (risk-shifting behavior) of banks.