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Sophistication in Risk Management, Bank Equity, and Stability

Author

Listed:
  • Jan Wenzelburger

    (Keele University, Centre for Economic Research and School of Economic and Management Studies)

  • Hans Gersbach

    (Center of Economic Research at ETH Zurich and CEPR)

Abstract

We investigate the question of whether sophistication in risk management fosters banking stability. We compare a simple banking system in which an average rating is used with a sophisticated banking system in which banks are able to assess the default risk of entrepreneurs individually. Both banking systems compete for deposits, loans, and bank equity. While a sophisticated system rewards entrepreneurs with low default risks with low loan interest rates, a simple system acquires more bank equity and finances more entrepreneurs. Expected repayments in a simple system are always higher and its default risk is lower if productivity is sufficiently high. Expected aggregate consumption of entrepreneurs, however, is higher in a sophisticated banking system.

Suggested Citation

  • Jan Wenzelburger & Hans Gersbach, 2007. "Sophistication in Risk Management, Bank Equity, and Stability," Keele Economics Research Papers KERP 2007/08, Centre for Economic Research, Keele University.
    • Handle: RePEc:kee:kerpuk:2007/08
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    File URL: http://www.keele.ac.uk/depts/ec/wpapers/kerp0708.pdf
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    2. Millicent Chang & Andrew B. Jackson & Marvin Wee, 2018. "A review of research on regulation changes in the Asia‐Pacific region," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 58(3), pages 635-667, September.

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    JEL classification:

    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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