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Sophistication in Risk Management, Bank Equity, and Stability

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  • 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)

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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Bibliographic 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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Keywords: Financial intermediation; macroeconomic risks; risk management; risk premia; banking regulation; rating.;

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  1. Bhattacharya Sudipto & Thakor Anjan V., 1993. "Contemporary Banking Theory," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 3(1), pages 2-50, October.
  2. Helmut Elsinger & Alfred Lehar & Martin Summer, 2006. "Using Market Information for Banking System Risk Assessment," International Journal of Central Banking, International Journal of Central Banking, International Journal of Central Banking, vol. 2(1), March.
  3. Gehrig, Thomas & Stenbacka, Rune, 2001. "Screening Cycles," CEPR Discussion Papers 2915, C.E.P.R. Discussion Papers.
  4. Harald Uhlig, 1996. "A law of large numbers for large economies (*)," Economic Theory, Springer, Springer, vol. 8(1), pages 41-50.
  5. Hans Gersbach & Jan Wenzelburger, 2004. "Do Risk Premia Protect from Banking Crises," Levine's Bibliography 122247000000000356, UCLA Department of Economics.
  6. Al-Najjar, Nabil Ibraheem, 1995. "Decomposition and Characterization of Risk with a Continuum of Random Variables," Econometrica, Econometric Society, Econometric Society, vol. 63(5), pages 1195-1224, September.
  7. Gunter Franke & Jan Pieter Krahnen, 2007. "Default Risk Sharing between Banks and Markets: The Contribution of Collateralized Debt Obligations," NBER Chapters, in: The Risks of Financial Institutions, pages 603-634 National Bureau of Economic Research, Inc.
  8. Krahnen, Jan Pieter & Weber, Martin, 2001. "Generally accepted rating principles: A primer," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 3-23, January.
  9. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  10. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  11. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers, Centro de Estudios Monetarios Y Financieros- 9516, Centro de Estudios Monetarios Y Financieros-.
  12. Gersbach, Hans & Uhlig, Harald, 2006. "Debt contracts and collapse as competition phenomena," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 15(4), pages 556-574, October.
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