Revision of the Basel Accord: Implications of the Co-Existence between the Standardized Approach and the Internal Ratings-Based Approach

Abstract

We examine the prudential implications of the co-existence between the standardized approach and the internal ratings-based (IRB) approach, as defined in the new Basel Accord. We consider an oligopoly model in which sophisticated banks, eligible for the IRB approach, and unsophisticated banks, eligible for the standardized approach, allocate their loan portfolio between high-risk and low-risk borrowers. We find that the co-existence between the two regimes may induce sophisticated banks to decrease risk-taking, but encourage unsophisticated banks to increase risk-taking. These risk allocation effects have implications for the optimal riskdifferentiation of the IRB capital requirements from the perspective of the deposit insurance scheme.

Keywords: Banking regulation, capital standards, Basel Accord

JEL Classification: G2, G28