Bank Competition and Capital Regulation

We analyze the effects of capital regulation on bank stability in a model where banks compete for loans and deposits, and where they face both a portfolio and an optimal contracting problem. In our setup, stricter capital regulation increases the risk of individual loans and may also increase a bank's probability of default because it relaxes the competition for loans. Therefore, capital regulation and competition have similar effects on bank stability, but with reversed signs: Stricter capital requirements tend to destabilize the banking sector when higher competition stabilizes it