Banks' Credit-Portfolio Choices and Risk-Based Capital Regulation

Caren Yinxia Nielsen

No 2016:9, Working Papers from Lund University, Department of Economics

Abstract: To address banks’ risk taking during the recent financial crisis, we develop a model of credit-portfolio optimization and study the impact of risk-based capital regulation (Basel Accords) on banks’ asset allocations. The model shows that, when a bank’s capital is constrained by regulation, regulatory cost (risk weightings in the Basel Accords) alters the risk and value calculations for the bank’s assets. The model predicts that the effect of a tightening of the capital requirements – for banks for which these requirements are (will become) binding – will be to skew the risky portfolio towards high-risk, high-earning assets (low-risk, low-earning assets), provided that the asset valuation – i.e., reward-to-regulatory-cost ratio – of the high-risk asset is higher than that of the low-risk asset. Empirical examination of U.S. banks supports the predictions applicable to the dataset. In addition, our tests show the characteristics of banks with different levels of risk taking. In particular, the core banks that use the internal ratings-based approach under Basel II invest more in high-risk assets.

Keywords: Banks; asset risk; credit risk; portfolio choice; risk-based capital regulation (search for similar items in EconPapers)
JEL-codes: G11 G18 G21 G28 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2016-06-13
New Economics Papers: this item is included in nep-ban, nep-net and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://lucris.lub.lu.se/ws/portalfiles/portal/194593374/WP16_9 Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hhs:lunewp:2016_009

Access Statistics for this paper

More papers in Working Papers from Lund University, Department of Economics School of Economics and Management, Box 7080, S-22007 Lund, Sweden. Contact information at EDIRC.
Bibliographic data for series maintained by Iker Arregui Alegria ().