Bank Capital Regulation with an Opportunistic Rating Agency

Efing, Matthias

doi:10.2139/ssrn.2050289

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Bank Capital Regulation with an Opportunistic Rating Agency

Swiss Finance Institute Research Paper No. 12-19

48 Pages Posted: 3 May 2012 Last revised: 22 Sep 2015

See all articles by Matthias Efing

Matthias Efing

HEC Paris - Finance Department; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

There are 2 versions of this paper

Date Written: September 15, 2015

Abstract

This paper models the strategic interaction between a rating agency, a bank and a bank regulator who lacks information about bank asset risk. The regulator can either (1) make bank capital requirements contingent on credit ratings; or (2) set rating independent capital requirements. Truthful ratings provide efficiency gains because they allow the regulator to constrain high risk bank investment without simultaneously reducing overall investment volume. However, if collusion between the rating agency and the bank corrupts rating quality, rating independent regulation enhances welfare. The welfare benefits are largest if regulators maintain rating contingent capital requirements and discipline rating agencies.

Keywords: Bank Regulation, Lucas Critique, Collusion, Ratings Inflation, Risk-shifting

JEL Classification: D82, G21, G24, G28

Suggested Citation: Suggested Citation

Efing, Matthias, Bank Capital Regulation with an Opportunistic Rating Agency (September 15, 2015). Swiss Finance Institute Research Paper No. 12-19, Available at SSRN: https://ssrn.com/abstract=2050289 or http://dx.doi.org/10.2139/ssrn.2050289