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Regulatory Practices and the Impossibility to Extract Truthful Risk Information

Author

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  • Patarick Leoni

    (Economics Department, National University of Ireland, Maynooth)

Abstract

We consider a regulator providing deposit insurance to a bank with private information about its investment portfolio. Following current regulatory practices, we assume that the regulator does not commit to audit and sanction after any risk report from the bank. We show that, in absence of commitment, the socially optimal contract leads a high-risk bank to misreport its risk with positive probability in most cases. We also isolate cases when truthful risk report is optimal. We thus establish that extraction of truthful risk information is not socially optimal in most cases given current regulatory practices.

Suggested Citation

  • Patarick Leoni, 2006. "Regulatory Practices and the Impossibility to Extract Truthful Risk Information," Economics Department Working Paper Series n1680906, Department of Economics, National University of Ireland - Maynooth.
    • Handle: RePEc:may:mayecw:n1680906
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    File URL: http://repec.maynoothuniversity.ie/mayecw-files/N1680906.pdf
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    Cited by:

    1. Wai‐Hong Ho & Yong Wang, 2013. "Asymmetric Information, Auditing Commitment, and Economic Growth," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 46(2), pages 611-633, May.

    More about this item

    Keywords

    Banking Regulation; Partial Commitment; Asymmetric Information; Adverse Selectio;
    All these keywords.

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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