Bank Capital and Misconduct Incentives

ABSTRACT This paper studies large banks' incentives to engage in misconduct by abusing their dominant position in the market for loans and by mis‐selling an add‐on financial product to depositors. We draw new connections between stability‐focused prudential regulation and misconduct by studying the impact of higher capital requirements on misconduct incentives. Higher capital requirements are more likely to increase misconduct incentives when incumbents enjoy a significant equity funding cost advantage over challenger banks. These results highlight the importance of regulatory coordination in the areas of bank conduct and financial stability.