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Capital Regulation and Tail Risk

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  • Enrico Perotti
  • Lev Ratnovski
  • Razvan Vlahu

Abstract

The paper studies risk mitigation associated with capital regulation, in a context where 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. Moreover, higher capital may have an unintended effect of enabling banks to take more tail risk without the fear of breaching the minimal capital ratio in non-tail risky project realizations. 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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Bibliographic Info

Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 307.

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Date of creation: Aug 2011
Date of revision:
Handle: RePEc:dnb:dnbwpp:307

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Keywords: Banking; Capital regulation; Risk-taking; Tail risk; Systemic risk;

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References

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Citations

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Cited by:
  1. Stefan Arping, 2014. "Does Competition make Banks more Risk-seeking?," Tinbergen Institute Discussion Papers 14-059/IV, Tinbergen Institute.
  2. 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.
  3. 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.
  4. Itai Agur, 2011. "Bank Risk within and across Equilibria," DNB Working Papers 305, Netherlands Central Bank, Research Department.
  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. Natalya Martynova & Lev Ratnovski & Razvan Vlahu, 2014. "Franchise value and risk-taking in modern banks," DNB Working Papers 430, Netherlands Central Bank, Research Department.
  7. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," Working Papers halshs-00796490, HAL.
  8. 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.
  9. Altunbas, Yener & Marqués-Ibáñez, David & Manganelli, Simone, 2011. "Bank risk during the financial crisis: do business models matter?," Working Paper Series 1394, European Central Bank.
  10. 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.).
  11. 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.
  12. Andrew G. Haldane, 2012. "Control Rights (And Wrongs)," Economic Affairs, Wiley Blackwell, vol. 32(2), pages 47-58, 06.
  13. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," AMSE Working Papers 1310, Aix-Marseille School of Economics, Marseille, France, revised Feb 2013.
  14. 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.

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