Cover; Bank Capitalization as a Signal; I. INTRODUCTION; II. THE MODEL; III. MODEL ANALYSIS; A. Full Information; B. Equilibria with Partial Information and Two Bank Types; Pooling; Separating; A parameterized example; C. Separating Equilibrium with Partial Information and a Continuum of Bank Types; IV. EXTENSIONS; A. Signaling over the Cycle; B. Risk Aversion; C. Investment in Loan Technology; V. SUMMARY AND CONCLUSIONS; REFERENCES; APPENDIX I: REGULARITY CONDITIONS ON THE OBJECTIVE FUNCTION WITH A CONTINUUM OF BANK TYPES
Summary
The level of a bank's capitalization can effectively transmit information about its riskiness and therefore support market discipline, but asymmetry information may induce exaggerated or distortionary behavior: banks may vie with one another to signal confidence in their prospects by keeping capitalization low, and banks' creditors often cannot distinguish among them -- tendencies that can be seen across banks and across time. Prudential policy is warranted to help offset these tendencies
