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Tailoring Bank Capital Regulation for Tail Risk

  • Nataliya Klimenko

    (AMSE - Aix-Marseille School of Economics - Aix-Marseille Univ. - Centre national de la recherche scientifique (CNRS) - École des Hautes Études en Sciences Sociales (EHESS) - Ecole Centrale Marseille (ECM))

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    The experience of the 2007-09 financial crisis has showed that the bank capital regulation in place was inadequate to deal with "manufacturing" tail risk in the financial sector. This paper proposes an incentive-based design of bank capital regulation aimed at efficiently dealing with tail risk engendered by bank top managers. It has two specific features: (i) first, it incorporates information on the optimal incentive contract between bank shareholders and bank managers, thereby dealing with the internal agency problem; (ii) second, it relies on the mechanism of mandatory recapitalization to ensure this contract is adopted by bank shareholders.

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    Paper provided by HAL in its series Working Papers with number halshs-00796490.

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    Date of creation: Feb 2013
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    Handle: RePEc:hal:wpaper:halshs-00796490
    Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00796490
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    1. Chen, Carl R. & Steiner, Thomas L. & Whyte, Ann Marie, 2006. "Does stock option-based executive compensation induce risk-taking? An analysis of the banking industry," Journal of Banking & Finance, Elsevier, vol. 30(3), pages 915-945, March.
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    3. Decamps, Jean-Paul & Rochet, Jean-Charles & Roger, Benoit, 2004. "The three pillars of Basel II: optimizing the mix," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 132-155, April.
    4. Sudipto Bhattacharya & Manfred Plank & Josef Zechner & Gunter Strobl, 2000. "Bank Capital Regulation With Random Audits," FMG Discussion Papers dp354, Financial Markets Group.
    5. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
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    7. International Monetary Fund, 2011. "Capital Regulation and Tail Risk," IMF Working Papers 11/188, International Monetary Fund.
    8. Samu Peura & Jussi Keppo, 2006. "Optimal Bank Capital with Costly Recapitalization," The Journal of Business, University of Chicago Press, vol. 79(4), pages 2163-2202, July.
    9. Bris, Arturo & Cantale, Salvatore, 2004. "Bank capital requirements and managerial self-interest," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(1), pages 77-101, February.
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    12. Patrick Bolton & Hamid Mehran & Joel Shapiro, 2010. "Executive compensation and risk taking," Staff Reports 456, Federal Reserve Bank of New York.
    13. Rochet, Jean-Charles & Villeneuve, Stéphane, 2011. "Liquidity management and corporate demand for hedging and insurance," Journal of Financial Intermediation, Elsevier, vol. 20(3), pages 303-323, July.
    14. Melissa A. Williams & Timothy B. Michael & Ramesh P. Rao, 2008. "Bank mergers, equity risk incentives, and CEO stock options," Managerial Finance, Emerald Group Publishing, vol. 34(5), pages 316-327.
    15. Koziol, Christian & Lawrenz, Jochen, 2012. "Contingent convertibles. Solving or seeding the next banking crisis?," Journal of Banking & Finance, Elsevier, vol. 36(1), pages 90-104.
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