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Bank optimal portfolio risk level under various regulatory requirements

  • Alexandra Girod

    (University of Nice)

  • Olivier Bruno

    (University of Nice)

We investigate the impact the risk sensitive regulatory ratio may have on banks' risk taking behaviours according to two aspects: potential effects induced by the implementation of a risk sensitivity ratio and cyclical impacts that could affect risk taking behaviour. We show that the risk sensitivity of capital requirements introduce by Basel II adds either a regulatory "bonus" or "penalty" on a bank that owns a fixed capital endowment. Depending on the magnitude of cyclical variations into requirements, the "bonus" may be exploited by the bank to increase its value toward the selection of a riskier asset or the "penalty" may restrict the bank to opt for a less risky asset. Whether the optimal asset risk level swings among classes of risk through the cycle, the risk level of bank's portfolio may increase during economic upturns, or decrease in downturns, leading to a rise in financial fragility or a "fly to quality" phenomenon.

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Paper provided by Observatoire Francais des Conjonctures Economiques (OFCE) in its series Documents de Travail de l'OFCE with number 2011-06.

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Date of creation: Mar 2011
Date of revision:
Handle: RePEc:fce:doctra:1106
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  1. Eva Catarineu-Rabell & Patricia Jackson & Dimitrios P Tsomocos, 2003. "Procyclicality and the new Basel Accord - banks' choice of loan rating system," Bank of England working papers 181, Bank of England.
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