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Regulation, Supervision, and Bank Risk-Taking

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Abstract

This paper presents a model of the interaction between a bank and a supervisor. The bank privately chooses the risk of its investment portfolio and the supervisor collects nonverifiable information on the future solvency of the bank and, based on of this information, may decide on its early liquidation. The paper characterizes the liquidation decision of the supervisor and the risk-taking decision of the bank. In line with recent empirical literature, the paper shows that supervision is effective in ameliorating the bank’s risk-shifting incentives, and that a tougher supervisor leads to lower risk-taking. It also shows that higher noise in the supervisory information may be conducive to lower risk-taking, but that it always reduces welfare.

Suggested Citation

  • Rafael Repullo, 2025. "Regulation, Supervision, and Bank Risk-Taking," Working Papers wp2025_2506, CEMFI.
    • Handle: RePEc:cmf:wpaper:wp2025_2506
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    References listed on IDEAS

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    1. Agarwal, Sumit & Morais, Bernardo & Seru, Amit & Shue, Kelly, 2024. "Noisy Experts? Discretion in Regulation," Research Papers 4180, Stanford University, Graduate School of Business.
    2. Carlos Altavilla & Miguel Boucinha & José-Luis Peydró & Frank Smets, 2019. "Banking supervision, monetary policy and risk-taking: Big data evidence from 15 credit registers," Economics Working Papers 1684, Department of Economics and Business, Universitat Pompeu Fabra, revised Dec 2020.
    3. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
    4. Beverly Hirtle & Anna Kovner & Matthew Plosser, 2020. "The Impact of Supervision on Bank Performance," Journal of Finance, American Finance Association, vol. 75(5), pages 2765-2808, October.
    5. Altavilla, Carlo & Boucinha, Miguel & Peydro, Jose-Luis & Jasova, Martina & Smets, Frank, 2020. "Supranational Banking Supervision, Credit Supply and Risk-Taking: European Evidence from Multi-Country Credit Registers," CEPR Discussion Papers 14288, Centre for Economic Policy Research.
    6. Sumit Agarwal & Bernardo C. Morais & Amit Seru & Kelly Shue, 2024. "Weighted Noise: Discretion in Regulation," NBER Working Papers 32344, National Bureau of Economic Research, Inc.
    7. Sumit Agarwal & David Lucca & Amit Seru & Francesco Trebbi, 2014. "Inconsistent Regulators: Evidence from Banking," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 129(2), pages 889-938.
    8. Mailath George J. & Mester Loretta J., 1994. "A Positive Analysis of Bank Closure," Journal of Financial Intermediation, Elsevier, vol. 3(3), pages 272-299, June.
    9. Repullo, Rafael, 2004. "Capital requirements, market power, and risk-taking in banking," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 156-182, April.
    10. Xavier Vives, 2016. "Competition and Stability in Banking: The Role of Regulation and Competition Policy," Economics Books, Princeton University Press, edition 1, number 10741, December.
    11. John Kandrac & Bernd Schlusche, 2021. "The Effect of Bank Supervision and Examination on Risk Taking: Evidence from a Natural Experiment," The Review of Financial Studies, Society for Financial Studies, vol. 34(6), pages 3181-3212.
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    Keywords

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    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
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact

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