The IRB model, bank regulatory arbitrage, and the Eurozone crisis

By using a novel dataset on bank-level exposures to specific countries, I investigate how model-based capital regulations can be misused by European banks for capital saving purposes during the Eurozone sovereign debt crisis. I find that relative to banks from core countries, banks from peripheral countries (1) could greatly reduce the risk-weight of their assets in capital requirement calculations by applying more model-based capital rules, and (2) that the default frequency of their assets is not properly reflected in their capital requirement calculations. These results indicate that banks from peripheral countries are more likely to conduct regulatory arbitrage against model-based capital rules.