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Capital Regulation and Tail Risk

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Listed:
  • Enrico Camillo Perotti
  • Lev Ratnovski
  • Razvan Vlahu

Abstract

The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk asserts. We show that this undermines the traditional result that high 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 Camillo Perotti & Lev Ratnovski & Razvan Vlahu, 2011. "Capital Regulation and Tail Risk," IMF Working Papers 2011/188, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:2011/188
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    More about this item

    Keywords

    Banking; Capital adequacy requirements; Tax incentives; Countercyclical capital buffers; Financial crises; WP; capital ratio; project choice; recapitalization decision; bank capital;
    All these keywords.

    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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