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Tailoring Bank Capital Regulation for Tail Risk

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  • Nataliya Klimenko

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    (Aix-Marseille University (Aix-Marseille School of Economics), CNRS & EHESS)

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    Abstract

    The experience of the 2007-09 financial crisis has showed that the bank capital regulation in place was inadequate to deal with "manufacturing" tail risk in the financial sector. This paper proposes an incentive-based design of bank capital regulation aimed at efficiently dealing with tail risk engendered by bank top managers. It has two specific features: (i) first, it incorporates information on the optimal incentive contract between bank shareholders and bank managers, thereby dealing with the internal agency problem; (ii) second, it relies on the mechanism of mandatory recapitalization to ensure this contract is adopted by bank shareholders.

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    File URL: http://www.amse-aixmarseille.fr/sites/default/files/_dt/2012/wp_2013_-_nr_10.pdf
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    Bibliographic Info

    Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1310.

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    Length: 30 pages
    Date of creation: Feb 2013
    Date of revision: Feb 2013
    Handle: RePEc:aim:wpaimx:1310

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    Web page: http://www.amse-aixmarseille.fr/en
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    Related research

    Keywords: Capital requirements; tail risk; recapitalization; incentive compensation; moral hazard.;

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    1. Bhattacharya, Sudipto & Plank, Manfred & Strobl, Gunter & Zechner, Josef, 2002. "Bank capital regulation with random audits," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 26(7-8), pages 1301-1321, July.
    2. Décamps, Jean-Paul & Mariotti, Thomas & Rochet, Jean-Charles & Villeneuve, Stéphane, 2008. "Free Cash-Flow, Issuance Costs and Stock Price Volatility," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 518, Institut d'Économie Industrielle (IDEI), Toulouse.
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    6. Mohamed Belhaj, 2011. "Excess capital, operational disaster risk, and capital requirements for banks," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 11(5), pages 653-661.
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    8. Decamps, Jean-Paul & Rochet, Jean-Charles & Roger, Benoit, 2004. "The three pillars of Basel II: optimizing the mix," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 13(2), pages 132-155, April.
    9. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
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    11. Bruno Biais & Thomas Mariotti & Jean-Charles Rochet & StÈphane Villeneuve, 2010. "Large Risks, Limited Liability, and Dynamic Moral Hazard," Econometrica, Econometric Society, Econometric Society, vol. 78(1), pages 73-118, 01.
    12. Samu Peura & Jussi Keppo, 2006. "Optimal Bank Capital with Costly Recapitalization," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 79(4), pages 2163-2202, July.
    13. Patrick Bolton & Hamid Mehran & Joel Shapiro, 2010. "Executive compensation and risk taking," Staff Reports, Federal Reserve Bank of New York 456, Federal Reserve Bank of New York.
    14. Rochet, Jean Charles & Villeneuve, Stéphane, 2004. "Liquidity Risk and Corporate Demand for Hedging and Insurance," CEPR Discussion Papers, C.E.P.R. Discussion Papers 4755, C.E.P.R. Discussion Papers.
    15. Melissa A. Williams & Timothy B. Michael & Ramesh P. Rao, 2008. "Bank mergers, equity risk incentives, and CEO stock options," Managerial Finance, Emerald Group Publishing, Emerald Group Publishing, vol. 34(5), pages 316-327.
    16. Bris, Arturo & Cantale, Salvatore, 2004. "Bank capital requirements and managerial self-interest," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 44(1), pages 77-101, February.
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