Eberhard Feess () (Aachen University (RWTH), Dept. of Economics, Templergraben 64, D-52056 Aachen) Ulrich Hege () (HEC School of Management, Department of Finance and Economics, F-78351 Jouy-en-Josas Cedex, France)
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The Basel Committee plans to differentiate risk-adjusted capital requirements between banks regulated under the internal ratings based (IRB) approach and banks under the standard approach. We investigate the consequences for the lending capacity and the failure risk of banks in a model with endogenous interest rates. The optimal regulatory response depends on the banks’ inclination to increase their portfolio risk. If IRB-banks are well-capitalized or gain little from taking risks, then they will increase their market share and hold safe portfolios. As risk-taking incentives become more important, the optimal portfolio size of banks adopting intern rating systems will be increasingly constrained, and ultimately they may lose market share relative to banks using the standard approach. The regulator has only limited options to avoid the excessive adoption of internal rating systems.
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Paper provided by Center for Financial Studies in its series CFS Working Paper Series with number
2004/25.
Length: 47 pages Date of creation: 25 Jan 2004 Date of revision: Handle: RePEc:cfs:cfswop:wp200425
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