Why the micro-prudential regulation fails? The impact on systemic risk by imposing a capital requirement
AbstractThis paper studies why the micro-prudential regulations fails to maintain a stable financial system by investigating the impact of micro-prudential regulation on the systemic risk in a cross-sectional dimension. We construct a static model for risk-taking behavior of financial institutions and compare the systemic risks in two cases with and without a capital requirement regulation. In a system with a capital requirement regulation, the individual risk-taking of the financial institutions are lower, whereas the systemic linkage within the system is higher. With a proper systemic risk measure combining both individual risks and systemic linkage, we find that, under certain circumstance, the systemic risk in a regulated system can be higher than that in a regulation-free system. We discuss a sufficient condition under which the systemic risk in a regulated system is always lower. Since the condition is based on comparing balance sheets of all institutions in the system, it can be verified only if information on risk-taking behaviors and capital structures of all institutions are available. This suggests that a macro-prudential framework is necessary for establishing banking regulations towards the stability of the financial system as a whole.
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Bibliographic InfoPaper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 256.
Date of creation: Jul 2010
Date of revision:
Banking regulation; systemic risk; capital requirement; macro-prudential regulation;
Find related papers by JEL classification:
- G01 - Financial Economics - - General - - - Financial Crises
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-08-14 (All new papers)
- NEP-BAN-2010-08-14 (Banking)
- NEP-BEC-2010-08-14 (Business Economics)
- NEP-FMK-2010-08-14 (Financial Markets)
- NEP-REG-2010-08-14 (Regulation)
- NEP-RMG-2010-08-14 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- De Vries, C.G., 2005.
"The simple economics of bank fragility,"
Journal of Banking & Finance,
Elsevier, vol. 29(4), pages 803-825, April.
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