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Dynamic Prudential Regulation

  • Afrasiab Mirza
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    This paper investigates regulations for banks that covered by deposit insurance in a dynamic setting where bankruptcy entails social costs. Regulatory policy operates through rules governing the bank's capital structure and asset allocation that may be adjusted each period. Throughout, the regulator must take into account that the bank is better informed about the inherent risks of its assets (adverse selection) and may forgo unobservable and costly actions to improve asset quality (moral hazard). Under the optimal regulatory policy under banks face risk-adjusted capital requirements but also hard-caps on size and leverage. In addition, the optimal policy counteracts pro-cyclical bank behaviour through the use of capital buffers.

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    File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/12-13.pdf
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    Paper provided by Department of Economics, University of Birmingham in its series Discussion Papers with number 12-13.

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    Length: 30 pages
    Date of creation: Dec 2012
    Date of revision:
    Handle: RePEc:bir:birmec:12-13
    Contact details of provider: Postal: Edgbaston, Birmingham, B15 2TT
    Web page: http://www.economics.bham.ac.uk

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    1. Doepke, Matthias & Townsend, Robert M, 2004. "Dynamic Mechanism Design with Hidden Income and Hidden Auctions," CEPR Discussion Papers 4455, C.E.P.R. Discussion Papers.
    2. Martin Hellwig, 2008. "Systemic Risk in the Financial Sector: An Analysis of the Subprime-Mortgage Financial Crisis," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2008_43, Max Planck Institute for Research on Collective Goods.
    3. Jean Tirole & Jean-Jaques Laffont, 1985. "Using Cost Observation to Regulate Firms," Working papers 368, Massachusetts Institute of Technology (MIT), Department of Economics.
    4. Rafael Repullo & Javier Suarez, 2012. "The Procyclical Effects Of Bank Capital Regulation," Working Papers wp2012_1202, CEMFI.
    5. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    6. Dangl, Thomas & Lehar, Alfred, 2004. "Value-at-risk vs. building block regulation in banking," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 96-131, April.
    7. Mailath, George J. & Samuelson, Larry, 2006. "Repeated Games and Reputations: Long-Run Relationships," OUP Catalogue, Oxford University Press, number 9780195300796, March.
    8. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    9. Blum, Jurg, 1999. "Do capital adequacy requirements reduce risks in banking?," Journal of Banking & Finance, Elsevier, vol. 23(5), pages 755-771, May.
    10. Myerson, Roger B., 1982. "Optimal coordination mechanisms in generalized principal-agent problems," Journal of Mathematical Economics, Elsevier, vol. 10(1), pages 67-81, June.
    11. Giammarino, Ronald M & Lewis, Tracy R & Sappington, David E M, 1993. " An Incentive Approach to Banking Regulation," Journal of Finance, American Finance Association, vol. 48(4), pages 1523-42, September.
    12. Athey, Susan & Bagwell, Kyle, 2001. "Optimal Collusion with Private Information," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 428-65, Autumn.
    13. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    14. Árpád Ábrahám & Nicola Pavoni, 2005. "The Efficient Allocation of Consumption under Moral Hazard and Hidden Access to the Credit Market," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 370-381, 04/05.
    15. Blum, Jurg & Hellwig, Martin, 1995. "The macroeconomic implications of capital adequacy requirements for banks," European Economic Review, Elsevier, vol. 39(3-4), pages 739-749, April.
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