Bank regulators interfere with the efficient allocation of resources for the sake of financial stability. Based on this trade-off, I compare how different capital requirements affect default probabilities and the allocation of market shares across heterogeneous banks. In the model, banks‘...

Some financial institutions can use internally developed credit risk models to determine their capital requirements. At the same time, the regulatory framework governing such models allows institutions to implement diverse rating systems with no specified penalty for poor model performance. To...