The paper derives optimal capital requirements, when the bank’s quality is private information. The supervisor can inspect the bank and punish the undercapitalized one with recapitalization and downsizing. The cost of bank’s capital and its ability to sell its assets are crucial for the...

Large banking organizations in the U.S. hold significantly more equity capital than the minimum required by bank regulators. This capital cushion has built up during a period of unusual profitability for the banking system, leading some observers to argue that the capital merely reflects recent...