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Dynamic Prudential Regulation

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  • Afrasiab Mirza

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.

Suggested Citation

  • Afrasiab Mirza, 2012. "Dynamic Prudential Regulation," Discussion Papers 12-13, Department of Economics, University of Birmingham.
    • Handle: RePEc:bir:birmec:12-13
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    File URL: https://repec.cal.bham.ac.uk/pdf/12-13.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Capital Regulation; Deposit Insurance; Risk-shifting;
    All these keywords.

    JEL classification:

    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • 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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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