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The Basel II Accord: Internal ratings and bank defferentiation

  • Fees, Eberhard
  • Hege, Ulrich

The Basel Committee plans to differentiate risk-adjusted capital requirements between banks regulated under the internal ratings based (IRB) approach and banks under the standard approach. We investigate the consequences for the lending capacity and the failure risk of banks in a model with endogenous interest rates. The optimal regulatory response depends on the banks’ inclination to increase their portfolio risk. If IRB-banks are well-capitalized or gain little from taking risks, then they will increase their market share and hold safe portfolios. As risk-taking incentives become more important, the optimal portfolio size of banks adopting intern rating systems will be increasingly constrained, and ultimately they may lose market share relative to banks using the standard approach. The regulator has only limited options to avoid the excessive adoption of internal rating systems.

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Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2004/25.

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Date of creation: 2004
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Handle: RePEc:zbw:cfswop:200425
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  1. Altman, Edward I. & Saunders, Anthony, 2001. "An analysis and critique of the BIS proposal on capital adequacy and ratings," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 25-46, January.
  2. Décamps, Jean-Paul & Rochet, Jean-Charles & Roger, Benoît, 2003. "The Three Pillars of Basel II, Optimizing the Mix," IDEI Working Papers 179, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. Calem, Paul & Rob, Rafael, 1999. "The Impact of Capital-Based Regulation on Bank Risk-Taking," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 317-352, October.
  4. Gropp, Reint & Richards, Anthony J., 2001. "Rating agency actions and the pricing of debt and equity of European banks: What can we infer about private sector monitoring of bank soundness?," Working Paper Series 0076, European Central Bank.
  5. Bhattacharya, S. & Boot, A.W.A. & Thakor, A.V., 1995. "The Economics of Bank Regulation," Papers 9516, Centro de Estudios Monetarios Y Financieros-.
  6. Craig Furfine, 2001. "Bank Portfolio Allocation: The Impact of Capital Requirements, Regulatory Monitoring, and Economic Conditions," Journal of Financial Services Research, Springer, vol. 20(1), pages 33-56, September.
  7. Besanko, David & Kanatas, George, 1996. "The Regulation of Bank Capital: Do Capital Standards Promote Bank Safety?," Journal of Financial Intermediation, Elsevier, vol. 5(2), pages 160-183, April.
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