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Sophistication in Risk Management, Bank Equity, and Stability

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Author Info
Jan Wenzelburger () (Keele University, Centre for Economic Research and School of Economic and Management Studies)
Hans Gersbach () (Center of Economic Research at ETH Zurich and CEPR)

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Abstract

We investigate the question of whether sophistication in risk management fosters banking stability. We compare a simple banking system in which an average rating is used with a sophisticated banking system in which banks are able to assess the default risk of entrepreneurs individually. Both banking systems compete for deposits, loans, and bank equity. While a sophisticated system rewards entrepreneurs with low default risks with low loan interest rates, a simple system acquires more bank equity and finances more entrepreneurs. Expected repayments in a simple system are always higher and its default risk is lower if productivity is sufficiently high. Expected aggregate consumption of entrepreneurs, however, is higher in a sophisticated banking system.

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File URL: http://www.keele.ac.uk/depts/ec/wpapers/kerp0708.pdf
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Publisher Info
Paper provided by Centre for Economic Research, Keele University in its series Keele Economics Research Papers with number KERP 2007/08.

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Length: 30 pages
Date of creation: Aug 2007
Date of revision:
Handle: RePEc:kee:kerpuk:2007/08

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Postal: Department of Economics, University of Keele, Keele, Staffordshire, ST5 5BG - United Kingdom
Phone: +44 (0)1782 584581
Fax: +44 (0)1782 717577
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Web page: http://www.keele.ac.uk/depts/ec/cer/
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Postal: Centre for Economic Research, Research Institute for Public Policy and Management, Keele University, Staffordshire ST5 5BG - United Kingdom
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Web: http://www.keele.ac.uk/depts/ec/cer/pubs_kerps.htm

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Related research
Keywords: Financial intermediation macroeconomic risks risk management risk premia banking regulation rating.

Other versions of this item:

Find related papers by JEL classification:
D40 - Microeconomics - - Market Structure and Pricing - - - General
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

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References listed on IDEAS
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.:
  1. Ruthira Naraidoo & Patrick Minford & Ioannis A. Venetis, 2006. "The political economy of unemployment and threshold effects. A nonlinear time series approach," Keele Economics Research Papers KERP 2006/21, Centre for Economic Research, Keele University. [Downloadable!]
  2. Elsinger, Helmut & Lehar, Alfred & Summer, Martin, 2005. "Using Market Information for Banking System Risk Assessment," MPRA Paper 817, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  3. Harald Uhlig, 1996. "A law of large numbers for large economies (*)," Economic Theory, Springer, vol. 8(1), pages 41-50.
  4. Krahnen, Jan Pieter & Weber, Martin, 2001. "Generally accepted rating principles: A primer," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 3-23, January. [Downloadable!] (restricted)
  5. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 393-414, July. [Downloadable!] (restricted)
  6. Günter Franke & Jan Pieter Krahnen, 2005. "Default Risk Sharing Between Banks and Markets: The Contribution of Collateralized Debt Obligations," CFS Working Paper Series 2005/06, Center for Financial Studies. [Downloadable!]
    Other versions:
  7. Bhattacharya, Sudipto & Boot, Arnoud W A & Thakor, Anjan V, 1998. "The Economics of Bank Regulation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 745-70, November.
    Other versions:
  8. Hans Gersbach & Jan Wenzelburger, 2004. "Do Risk Premia Protect from Banking Crises," Levine's Bibliography 122247000000000356, UCLA Department of Economics. [Downloadable!]
    Other versions:
  9. Al-Najjar, Nabil Ibraheem, 1995. "Decomposition and Characterization of Risk with a Continuum of Random Variables," Econometrica, Econometric Society, vol. 63(5), pages 1195-1224, September. [Downloadable!] (restricted)
  10. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, vol. 3(1), pages 2-50, October. [Downloadable!] (restricted)
  11. Gehrig, Thomas & Stenbacka, Rune, 2001. "Screening Cycles," CEPR Discussion Papers 2915, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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