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Capital Regulation and Tail Risk

Author

Listed:
  • Enrico Perotti

    (University of Amsterdam, De Nederlandsche Bank, and Duisenberg School of Finance)

  • Lev Ratnovski

    (International Monetary Fund)

  • Razvan Vlahu

    (De Nederlandsche Bank)

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.

Suggested Citation

  • Enrico Perotti & Lev Ratnovski & Razvan Vlahu, 2011. "Capital Regulation and Tail Risk," International Journal of Central Banking, International Journal of Central Banking, vol. 7(4), pages 123-163, December.
  • Handle: RePEc:ijc:ijcjou:y:2011:q:4:a:5
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. 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.
    2. Mariathasan, Mike & Merrouche, Ouarda, 2014. "The manipulation of basel risk-weights," Journal of Financial Intermediation, Elsevier, vol. 23(3), pages 300-321.
    3. 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.
    4. Košak, Marko & Li, Shaofang & Lončarski, Igor & Marinč, Matej, 2015. "Quality of bank capital and bank lending behavior during the global financial crisis," International Review of Financial Analysis, Elsevier, vol. 37(C), pages 168-183.
    5. Costas N. Kanellopoulos, 2012. "Employment and worker flows during the financial crisis," Economic Bulletin, Bank of Greece, issue 36, pages 31-41, April.
    6. repec:mir:mirbus:v:7:y:2017:i:2:p:1-12 is not listed on IDEAS
    7. Agur, Itai, 2014. "Bank risk within and across equilibria," Journal of Banking & Finance, Elsevier, vol. 48(C), pages 322-333.
    8. Altunbas, Yener & Manganelli, Simone & Marques-Ibanez, David, 2017. "Realized bank risk during the great recession," Journal of Financial Intermediation, Elsevier, vol. 32(C), pages 29-44.
    9. 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.
    10. Liu, Keqing, 2016. "Bank equity and macroprudential policy," Journal of Economic Dynamics and Control, Elsevier, vol. 73(C), pages 1-17.
    11. Nataliya Klimenko, 2013. "Tailoring Bank Capital Regulation for Tail Risk," Working Papers halshs-00796490, HAL.
    12. Scott Smith & Jesse Weiher, 2012. "Countercyclical Capital Regime – A Proposed Design and Empirical Evaluation," FHFA Staff Working Papers 12-02, Federal Housing Finance Agency.
    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. Andrew G. Haldane, 2012. "Control Rights (And Wrongs)," Economic Affairs, Wiley Blackwell, vol. 32(2), pages 47-58, June.
    15. 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.
    16. Kleinow, Jacob & Moreira, Fernando, 2016. "Systemic risk among European banks: A copula approach," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 42(C), pages 27-42.
    17. 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.
    18. Manganelli, Simone & Altunbas, Yener & Marqués-Ibáñez, David, 2011. "Bank risk during the financial crisis: do business models matter?," Working Paper Series 1394, European Central Bank.
    19. Jacob Kleinow & Tobias Nell, 2015. "Determinants of systemically important banks: the case of Europe," Journal of Financial Economic Policy, Emerald Group Publishing, vol. 7(4), pages 446-476, November.
    20. Black, Lamont & Correa, Ricardo & Huang, Xin & Zhou, Hao, 2016. "The systemic risk of European banks during the financial and sovereign debt crises," Journal of Banking & Finance, Elsevier, vol. 63(C), pages 107-125.
    21. Natalya Martynova & Lev Ratnovski & Razvan Vlahu, 2014. "Franchise value and risk-taking in modern banks," DNB Working Papers 430, Netherlands Central Bank, Research Department.
    22. Natalya Martynova & Lev Ratnovski & Razvan Vlahu, 2015. "Bank Profitability and Risk-Taking," IMF Working Papers 15/249, International Monetary Fund.
    23. Stefan Arping, 2014. "Does Competition make Banks more Risk-seeking?," Tinbergen Institute Discussion Papers 14-059/IV, Tinbergen Institute.
    24. Maarten van Oordt & Chen Zhou, 2014. "Systemic risk and bank business models," DNB Working Papers 442, Netherlands Central Bank, Research Department.

    More about this item

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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