Strategic Selection of Risk Models and Bank Capital Regulation
55 Pages Posted: 3 Nov 2012 Last revised: 27 Aug 2014
There are 2 versions of this paper
Strategic Selection of Risk Models and Bank Capital Regulation
Rational Blinders: Strategic Selection of Risk Models and Bank Capital Regulation
Date Written: August 26, 2014
Abstract
Using banks' internal models for regulatory purposes, while aimed at making capital requirements more accurate, invites regulatory arbitrage. I show how the strategic use of risk models can be avoided by penalizing banks with low risk-weights when they suffer abnormal losses. As defaulting banks cannot be penalized, under tail risk uncertainty it is optimal to "reward" banks that truthfully reveal high risk measures by a commitment to bailing them out in case of default. Recent regulatory reforms that use floors on risk weights instead can be counter-productive when the issue is a "hidden model" problem and not model risk.
Keywords: Basel risk-weights, internal risk models, leverage ratio, tail risk
JEL Classification: D82, D84, G21, G32, G38
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
How Accurate are Value-at-Risk Models at Commercial Banks
By Jeremy Berkowitz and James M. O'brien
-
The Predictive Ability of Several Models of Exchange Rate Volatility
By Kenneth D. West and Dongchul Cho
-
Bank Capital and Value at Risk
By Patricia Jackson, David Maude, ...
-
Bank Capital Requirements for Market Risk: The Internal Models Approach
By Darryll Hendricks and Beverly Hirtle