Regulation, Credit Risk Transfer, and Bank Lending
AbstractWe integrate Basel II (and III) regulations into the industrial organization approach to banking and analyze lending behavior and risk sensitivity of a risk-neutral bank. The bank is exposed to credit risk and may use credit default swaps (CDS) for hedging purposes. Regulation is found to induce the risk-neutral bank to behave in a more risk-sensitive way: Compared to a situation without regulation the optimal volume of loans decreases more as the riskiness of loans increases. CDS trading is found to interact with the former effect when regulation accepts CDS as an instrument to mitigate credit risk. Under the Substitution Approach in Basel II (and III) a risk-neutral bank will over-, fully or under-hedge its total exposure to credit risk conditional on the CDS price being downward biased, unbiased or upward biased. This interaction promotes the intention of the Basel II (and III) regulations to “strengthen the soundness and stability of banks”, since capital adequacy regulation without accounting for the risk-mitigating effect of CDS trading would stimulate a risk-neutral bank to take more extreme positions in the CDS market.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Universitaet Augsburg, Institute for Economics in its series Discussion Paper Series with number 316.
Date of creation: Feb 2011
Date of revision:
Contact details of provider:
Postal: Universitaetsstrasse 16, D-86159 Augsburg, Germany
Phone: +49 821 598 4060
Fax: +49 821 598 4217
Web page: http://www.wiwi.uni-augsburg.de/vwl/institut
More information through EDIRC
banking; regulation; credit risk;
Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-02 (All new papers)
- NEP-BAN-2011-04-02 (Banking)
- NEP-FMK-2011-04-02 (Financial Markets)
- NEP-REG-2011-04-02 (Regulation)
- NEP-RMG-2011-04-02 (Risk Management)
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dr. Albrecht Bossert).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.