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Capital Regulation and Tail Risk

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Author Info

  • Enrico Perotti

    (University of Amsterdam, Duisenberg school of finance, and CEPR)

  • Lev Ratnovski

    (International Monetary Fund)

  • Razvan Vlahu

    (Dutch Central Bank)

Abstract

The paper studies risk mitigation associated with capital regulation, in a context when banks may choose tail risk assets. We show that this undermines the traditional result that higher capital reduces excess risk-taking driven by limited liability. When capital raising is costly, poorly capitalized banks may limit risk to avoid breaching the minimal capital ratio. A bank with higher capital has lesschance of breaching the ratio, so may actually take more risk. As a result, banks which have access to tail risk projects may take greater risk when highly capitalized.The results are consistent with stylized facts about pre-crisis bank behavior, and suggest implications for the optimal design of capital regulation.

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File URL: http://papers.tinbergen.nl/11039.pdf
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Bibliographic Info

Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 11-039/2/DSF14.

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Date of creation: 17 Feb 2011
Date of revision: 31 Mar 2011
Handle: RePEc:dgr:uvatin:20110039

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Web page: http://www.tinbergen.nl

Related research

Keywords: Bank Regulation; Risk Shifting; Capital Requirements; Tail Risk; Systemic Risk;

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Citations

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Cited by:
  1. Maria J. Nieto & Gillian G. Garcia, 2012. "The insufficiency of traditional safety nets: what bank resolution fund for Europe?," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 20(2), pages 116-146, May.
  2. Chris Bloor & Rebecca Craigie & Anella Munro, 2012. "The macroeconomic effects of a stable funding requirement," Reserve Bank of New Zealand Discussion Paper Series DP2012/05, Reserve Bank of New Zealand.
  3. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," AMSE Working Papers 1310, Aix-Marseille School of Economics, Marseille, France, revised Feb 2013.
  4. Maria J. Nieto & Gillian G. Garcia, 2012. "The Insufficiency of Traditional Safety Nets: What Bank Resolution Fund for Europe?," FMG Special Papers sp209, Financial Markets Group.
  5. Mike Mariathasan & Ouarda Merrouche, 2012. "The Manipulation of Basel Risk-Weights. Evidence from 2007-10," Economics Series Working Papers 621, University of Oxford, Department of Economics.
  6. Gola Carlo & Ilari Antonio, 2013. "Financial innovation oversight: a policy framework," Questioni di Economia e Finanza (Occasional Papers) 200, Bank of Italy, Economic Research and International Relations Area.
  7. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," Working Papers halshs-00796490, HAL.
  8. Andrew G. Haldane, 2012. "Control Rights (And Wrongs)," Economic Affairs, Wiley Blackwell, vol. 32(2), pages 47-58, 06.
  9. Lamont Black & Ricardo Correa & Xin Huang & Hao Zhou, 2013. "The systemic risk of European banks during the financial and sovereign debt crises," International Finance Discussion Papers 1083, Board of Governors of the Federal Reserve System (U.S.).
  10. Yener Altunbas & Simone Manganelli & David Marques-Ibanez, 2012. "Bank Risk during the Financial Crisis: Do business models matter?," Working Papers 12003, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
  11. Costas N. Kanellopoulos, 2012. "Employment and worker flows during the financial crisis," Economic Bulletin, Bank of Greece, Economic Research Department, issue 36, pages 31-41, April.
  12. Stefan Arping, 2014. "Does Competition make Banks more Risk-seeking?," Tinbergen Institute Discussion Papers 14-059/IV, Tinbergen Institute.

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