The dynamics of a banking duopoly with capital regulations

This paper analyses the dynamics of a banking duopoly game with heterogeneous and homogeneous players (as regards the type of expectations' formation), to investigate the effects of the capital requirements introduced by international accords (Basel-I in 1988 and more recently Basel-II and Basel-III), in the context of the Monti-Klein model. This analysis reveals that the policy of introducing a capital requirement tends to stabilise the market equilibrium (both with heterogeneous and homogeneous banks). Moreover, it is shown that 1) when the capital standard is reduced the market stability is lost through a flip bifurcation and subsequently a cascade of flip bifurcations may lead to periodic cycles and chaos; 2) when the expectations are heterogeneous even the case of multi-stability may be present. Therefore, although on the one side the capital regulation is harmful for the equilibrium loans' volume and profit, on the other side it is effective in keeping or restoring the stability of the Coumot-Nash equilibrium in the banking duopoly. (C) 2013 Elsevier B.V. All rights reserved.