Internal Models-Based Capital Regulation and Bank Risk-Taking Incentives

Advocates for internal model-based capital regulation argue that this approach will reduce costs and remove distortions that are created by rules-based capital regulations. These claims are examined using a Merton-style model of deposit insurance. Analysis shows that internal model-based capital estimates are biased by safety-net-generated funding subsidies that convey to bank shareholders when market and credit risk regulatory capital requirements are set using bank internal model estimates. These subsidies are not uniform across the risk spectrum, and, as a consequence, internal model regulatory capital requirements will cause distortions in bank lending behavior.
Publication date: July 2002
ISBN: 9781451854831
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Banks and Banking , Banks and Banking , Finance , Finance , bond , deposit insurance , bonds , capital requirement , stock capital , Financial Institutions and Services: Government Policy and Regulation , Regulatory Capital Requirements , Credit Var , Internal Models

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