Prudent Banks and Creative Mimics: Can We Tell the Difference?

Andrew Powell, Marcus Miller and Antonia Maier

No 4760, Research Department Publications from Inter-American Development Bank, Research Department

Abstract: The recent financial crisis has forced a rethink of banking regulation and supervision and the role of financial innovation. This paper develops a model where prudent banks may signal their type through high capital ratios. Capital regulation may ensure separation in equilibrium, but deposit insurance will tend to increase the level of capital required. If supervision detects risky behavior ex ante then it is complementary to capital regulation. However, financial innovation may erode supervisors’ ability to detect risk and capital levels should then be higher. Regulators, however, may not be aware their capacities have been undermined. The paper argues for a four-prong policy response with higher bank capital ratios, enhanced supervision, limits to the use of complex financial instruments and Coco’s. The results may support the institutional arrangements proposed recently in the United Kingdom.

JEL-codes: D82 G21 G38 L51 (search for similar items in EconPapers)
Date: 2011-12
New Economics Papers: this item is included in nep-ban
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Related works:
Working Paper: Prudent Banks and Creative Mimics: Can we tell the difference? (2012)
Working Paper: Prudent Banks and Creative Mimics: Can We Tell the Difference? (2011)
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