Risk shifting and the allocation of capital: A Rationale for macroprudential regulation

Michael Kogler ()

Journal of Banking & Finance, 2020, vol. 118, issue C

Abstract: This paper reconsiders the risk-shifting problem of banks and presents a novel rationale for macroprudential regulation. The interplay between this agency problem and equilibrium investment creates a welfare-reducing pecuniary externality that causes capital misallocation and excessive bank risk taking. Therefore, the banking sector tends to be too large, under-capitalized, and inefficiently risky. This distortion is independent of typical frictions like government guarantees or default costs. Macroprudential regulation with capital requirements or deposit rate ceilings corrects misallocation thereby magnifying rent opportunities for banks to reduce risk shifting. Regulation is, however, no Pareto improvement and causes redistribution from households to bank owners.

Keywords: Macroprudential regulation; Risk taking; Pecuniary externalities; Misallocation (search for similar items in EconPapers)
JEL-codes: D60 D62 G21 G28 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:118:y:2020:i:c:s0378426620301564

DOI: 10.1016/j.jbankfin.2020.105890

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