The Pre-Commitment Approach: Using Incentives to Set Market Risk Capital Requirements
52 Pages Posted: 29 Jul 1997
Date Written: March 1997
Abstract
This paper develops a model of bank behavior that focuses on the interaction between the incentives created by fixed rate deposit insurance and a bank's choice of its loan portfolio and its portfolio of market-traded financial assets. The model is used to analyze the consequences of adopting the Federal Reserve Board's proposed Pre-Commitment Approach (PCA) for setting capital requirements for the market risks of a bank's trading portfolio. Under the PCA, a bank sets its own market risk capital requirement with the knowledge that it will face regulatory penalties should its trading activities generate subsequent losses that exceed its market risk capital pre-commitment.
JEL Classification: G21, G28
Suggested Citation: Suggested Citation
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