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Ex Ante Versus Ex Post Regulation of Bank Capital

Arup Daripa () and Simone Varotto ()

Finance from EconWPA

Abstract: The current debate on the new Basel Accord gives rise to a natural question about the appropriate form of capital regulation.We construct a simple framework to analyze this issue. In our model the risk carried by a bank as well as managerial risk preference are a bank's private information. We show that ex ante constraints waste the superior risk information of a bank, while an ex post regime makes full use of it. However, the latter is more vulnerable to the problem of unknown managerial risk-aversion. The results imply that the two regimes are complements, rather than substitutes. Further, under plausible conditions, an ex post regime emerges as the dominant element of the optimal combination. We use the results to shed light on current policy concerns. In particular, our results provides theoretical underpinning for the inclusion of pillar 2 alongside pillar 1 in Basel II.

Keywords: Ex Ante Regulation; Ex Post Regulation; Asymmetric Information; Safety Loss; Overprotection Loss; Safety Bias; Basel II. (search for similar items in EconPapers)
JEL-codes: G28 D82 L51 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fin and nep-fmk
Date: 2005-11-17
Note: Type of Document - pdf; pages: 50
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Working Paper: Ex Ante Versus Ex Post Regulation of Bank Capital (2005) Downloads
Working Paper: Ex Ante versus Ex Post Regulation of Bank Capital (2004) Downloads
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