Effectiveness of capital regulation at US commercial banks, 1985 to 1994

Unless priced and administered appropriately, a governmental safety net enh ances risk-shifting opportunities far banks. This paper quantifies regulato ry efforts to use capital requirements to control risk-shifting by U.S. ban ks during 1985 to 1994 and investigates how much risk-based capital require ments and other deposit-insurance reforms improved this control. We find th at capital discipline did not prevent large banks from shifting risk onto t he safety net. Banks with low capital and debt-to-deposits ratios overcame outside discipline better than other banks. Mandates introduced by 1991 leg islation have improved but did not establish full regulatory control over b ank risk-shifting incentives.