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Working Paper

Regulatory Taxes, Investment, and Financing Decisions for Insured Banks

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This article develops a two-factor model of bank behavior under credit and interest rate risk. In addition to flat-rate government deposit guarantees, we assume banks possess charter values that are lost if audits reveal that their tangible assets cannot cover their liabilities. Within this framework, we investigate the effects of interest rate and credit risk on optimal capital structure and investment decisions. We then show that with no uncertainty in interest rates, capital regulation will reduce the risk of the assets in the bank. However, with interest rate uncertainty, the impact of regulation may be detrimental and raise the risk of the deposits as well as the government subsidies to the shareholders of the bank.
05.01.1993ISSN 2573-7953 WP 93-03DOI 10.26509/frbc-wp-199303

Working Papers of the Federal Reserve Bank of Cleveland are preliminary materials circulated to stimulate discussion and critical comment on research in progress. They may not have been subject to the formal editorial review accorded official Federal Reserve Bank of Cleveland publications. The views expressed in this paper are those of the authors and do not represent the views of the Federal Reserve Bank of Cleveland or the Federal Reserve System.

Suggested Citation

Li, Anlong, Peter Ritchken, L. Sankarasubramanian, and James B. Thomson. 1993. “Regulatory Taxes, Investment, and Financing Decisions for Insured Banks.” Federal Reserve Bank of Cleveland, Working Paper No. 93-03. https://doi.org/10.26509/frbc-wp-199303