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The current U.S. bank capital regulation features prompt corrective action, which mandates regulators to intervene in and liquidate banks based on their book‐value capital ratios. To see if prompt corrective action is optimal, I build a dynamic model of repeated interactions between a banker and a regulator. Under hidden choice of risk, private information on returns and limited commitment by the banker, and costly liquidation, I first characterize the optimal incentive‐feasible allocation. I then demonstrate that the optimal allocation is implementable through the combination of a risk‐based deposit insurance premium and a book‐value capital regulation with stochastic liquidation.