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Refined Risk Assessment and Banking Stability

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  • Hans Gersbach
  • Jan Wenzelburger

Abstract

Current banking regulatory frameworks are based on the belief that refined assessment of credit risks improves banking stability. This paper investigates this claim in a general setting by comparing a simple banking system with a sophisticated banking system which is capable of assessing default risks of entrepreneurs more accurately. By charging actuarially fair loan-interest rates, the sophisticated system finances fewer entrepreneurs. Relative to the simple system, both their repayments and liabilities are lower. Expected aggregate profits of entrepreneurs are higher but consumers receive lower deposit rates. Refined risk assessment may increase the systemic default risk of a banking system if bank equity is too low. Requiring higher bank equity ratios and forcing banks to refine their risk assessment techniques tend to increase stability if taken together, but may not be successful if only the latter is implemented. We draw implications for the policy debate, sparked by the financial crisis.

Suggested Citation

  • Hans Gersbach & Jan Wenzelburger, "undated". "Refined Risk Assessment and Banking Stability," Working Papers ETH-RC-13-005, ETH Zurich, Chair of Systems Design.
    • Handle: RePEc:stz:wpaper:eth-rc-13-005
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    References listed on IDEAS

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