Strategic Selection of Risk Models and Bank Capital Regulation

Jean-Edouard Colliard

No 1229, HEC Research Papers Series from HEC Paris

Abstract: The regulatory use of banks' internal models makes capital requirements more risk-sensitive but invites regulatory arbitrage. I develop a framework to study bank regulation with strategic selection of risk models. A bank supervisor can discourage arbitrage by auditing risk models, and implements capital ratios less risk-sensitive than in the first-best to reduce auditing costs. The optimal capital ratios of a national supervisor can be different from those set by supranational authorities, in which case the supervisor optimally tolerates biased models. I discuss the empirical implications of this "hidden model" problem, and policy answers such as leverage ratios and more reliance on backtesting mechanisms.

Keywords: basel risk-weights; internal risk models; leverage ratio; supervisory audits (search for similar items in EconPapers)
JEL-codes: D82 D84 G21 G32 G38 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2017-09-01, Revised 2017-11-29
New Economics Papers: this item is included in nep-ban and nep-rmg
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Strategic Selection of Risk Models and Bank Capital Regulation (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:ebg:heccah:1229

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