The Limits of Model-Based Regulation

Markus Behn, Rainer Haselmann () and Vikrant Vig

No 20, LawFin Working Paper Series from Goethe University, Center for Advanced Studies on the Foundations of Law and Finance (LawFin)

Abstract: Using loan-level data from Germany, we investigate how the introduction of model-based capital regulation affected banks' ability to absorb shocks. The objective of this regulation was to enhance financial stability by making capital requirements responsive to asset risk. Our evidence suggests that banks 'optimized' model-based regulation to lower their capital requirements. Banks systematically underreported risk, with under reporting being more pronounced for banks with higher gains from it. Moreover, large banks benefitted from the regulation at the expense of smaller banks. Overall, our results suggest that sophisticated rules may have undesired effects if strategic misbehavior is difficult to detect.

Keywords: capital regulation; internal ratings; complexity of regulation; Basel regulation (search for similar items in EconPapers)
JEL-codes: G01 G21 G28 (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-ban, nep-cba, nep-reg and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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https://www.econstor.eu/bitstream/10419/244700/1/lawfin-wp20.pdf (application/pdf)

Related works:
Journal Article: The Limits of Model‐Based Regulation (2022)
Working Paper: The limits of model-based regulation (2016)
Working Paper: The limits of model-based regulation (2014)
Working Paper: The limits of model-based regulation (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:lawfin:20

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