Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough? By Thomas F. Hellmann, Kevin C. Murdock, and Joseph E. Stiglitz This paper examines the role of capital requirements in addressing moral hazard in banking and whether they are sufficient for prudential regulation. It argues that capital requirements alone are insufficient to achieve Pareto-efficient outcomes because they reduce gambling incentives but also harm banks' franchise values, encouraging gambling. The paper suggests that deposit-rate controls can be used in conjunction with capital requirements to achieve more efficient outcomes. It also highlights the role of financial liberalization in increasing competition, which can lead to moral hazard and financial crises. The paper concludes that deposit-rate ceilings can be an effective tool of prudential regulation, as they can limit the incentives for banks to engage in risky behavior. The paper also discusses the importance of monitoring banks' risk-management systems and the need for a combination of regulatory instruments to ensure financial stability. The paper emphasizes the need for a balanced approach to prudential regulation that takes into account the dynamic nature of financial markets and the potential for moral hazard.Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough? By Thomas F. Hellmann, Kevin C. Murdock, and Joseph E. Stiglitz This paper examines the role of capital requirements in addressing moral hazard in banking and whether they are sufficient for prudential regulation. It argues that capital requirements alone are insufficient to achieve Pareto-efficient outcomes because they reduce gambling incentives but also harm banks' franchise values, encouraging gambling. The paper suggests that deposit-rate controls can be used in conjunction with capital requirements to achieve more efficient outcomes. It also highlights the role of financial liberalization in increasing competition, which can lead to moral hazard and financial crises. The paper concludes that deposit-rate ceilings can be an effective tool of prudential regulation, as they can limit the incentives for banks to engage in risky behavior. The paper also discusses the importance of monitoring banks' risk-management systems and the need for a combination of regulatory instruments to ensure financial stability. The paper emphasizes the need for a balanced approach to prudential regulation that takes into account the dynamic nature of financial markets and the potential for moral hazard.