Strategic Selection of Risk Models and Bank Capital Regulation

Jean-Edouard Colliard

Management Science, 2019, vol. 67, issue 6, 2591-2606

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. The online appendix is available at https://doi.org/10.1287/mnsc.2017.2898 . This paper was accepted by Amit Seru, finance.

Keywords: Basel risk weights; internal risk models; leverage ratio; supervisory audits (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

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Related works:
Working Paper: Strategic Selection of Risk Models and Bank Capital Regulation (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:65:y:2019:i:6:p:2591-2606

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