Capital Regulation and Tail Risk

Enrico Perotti, Lev Ratnovski () and Razvan Vlahu

Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: This discussion paper resulted in a publication in the 'International Journal of Central Banking' , December 2011, 123-163.

The paper studies risk mitigation associated with capital regulation, in a context when banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. When capital raising is costly, poorly capitalized banks may limit risk to avoid breaching the minimal capital ratio. A bank with higher capital has lesschance of breaching the ratio, so may actually take more risk. As a result, banks which have access to tail risk projects may take greater risk when highly capitalized.The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.

Keywords: Bank Regulation; Risk Shifting; Capital Requirements; Tail Risk; Systemic Risk (search for similar items in EconPapers)
JEL-codes: E6 F3 F4 G2 G3 O16 (search for similar items in EconPapers)
Date: 2011-02-17, Revised 2011-03-31
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (35)

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https://papers.tinbergen.nl/11039.pdf (application/pdf)

Related works:
Journal Article: Capital Regulation and Tail Risk (2011)
Working Paper: Capital Regulation and Tail Risk (2011)
Working Paper: Capital Regulation and Tail Risk (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20110039

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