Sophistication in Risk Management, Bank Equity, and Stability*

Hans Gersbach and Jan Wenzelburger ()

International Review of Finance, 2010, vol. 10, issue 1, 63-91

Abstract: We investigate the question of whether sophistication in risk management fosters banking stability. We compare a simple banking system that uses an average rating with a sophisticated banking system in which banks are able to assess the default risk of entrepreneurs individually. Both banking systems compete for deposits, loans, and bank equity. While a sophisticated system rewards entrepreneurs with low default risks with low loan interest rates, a simple system acquires more bank equity and finances more entrepreneurs. Expected repayments in a simple system are always higher and its default risk may be lower. As an economy with a sophisticated banking system invests its funds more efficiently, there is a trade‐off between efficiency and stability of a banking system.

Date: 2010
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https://doi.org/10.1111/j.1468-2443.2010.01105.x

Related works:
Working Paper: Sophistication in Risk Management, Bank Equity, and Stability (2007)
Working Paper: Sophistication in Risk Management, Bank Equity, and Stability (2007)
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