This paper examines risk-taking incentives in banks under different accounting regimes with capital regulation. In the model the bank's decisions of capital issuance and investment policy are jointly determined. Given some exogenous minimum capital requirement, lower-of-costor-market accounting is the most effective regime that induces the bank to issue more excess equity capital above the minimum required level and implement less risky investment policy. However, the disciplining role of

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... of-cost-or-market accounting may discourage the bank from exerting project discovery effort ex-ante. From the regulator's perspective, the optimal accounting choice will be governed by a tradeoff between the social cost of capital regulation and the efficiency of the bank's project discovery efforts. When the former effect dominates, the regulator prefers lower-of-cost-or-market accounting; when the latter effect dominates, the regulator may prefer other regimes.