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Dynamic Prudential Regulation

Afrasiab Mirza

Discussion Papers from Department of Economics, University of Birmingham

Abstract: This paper investigates regulations for banks that covered by deposit insurance in a dynamic setting where bankruptcy entails social costs. Regulatory policy operates through rules governing the bank's capital structure and asset allocation that may be adjusted each period. Throughout, the regulator must take into account that the bank is better informed about the inherent risks of its assets (adverse selection) and may forgo unobservable and costly actions to improve asset quality (moral hazard). Under the optimal regulatory policy under banks face risk-adjusted capital requirements but also hard-caps on size and leverage. In addition, the optimal policy counteracts pro-cyclical bank behaviour through the use of capital buffers.

Keywords: Capital Regulation; Deposit Insurance; Risk-shifting (search for similar items in EconPapers)
JEL-codes: G2 G21 G28 G3 G32 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2012-12
New Economics Papers: this item is included in nep-cba, nep-cta, nep-ias and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:bir:birmec:12-13

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