Sophistication in Risk Management, Bank Equity, and Stability

29 Pages Posted: 1 Mar 2010

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Jan Wenzelburger

Bielefeld University - Department of Business Administration and Economics

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Abstract

We investigate the question of whether sophistication in risk management fosters banking stability. We compare a simple banking system that uses an average rating with a sophisticated banking system in which banks are able to assess the default risk of entrepreneurs individually. Both banking systems compete for deposits, loans, and bank equity. While a sophisticated system rewards entrepreneurs with low default risks with low loan interest rates, a simple system acquires more bank equity and finances more entrepreneurs. Expected repayments in a simple system are always higher and its default risk may be lower. As an economy with a sophisticated banking system invests its funds more efficiently, there is a trade-off between efficiency and stability of a banking system.

Suggested Citation

Gersbach, Hans and Wenzelburger, Jan, Sophistication in Risk Management, Bank Equity, and Stability. International Review of Finance, Vol. 10, Issue 1, pp. 63-91, March 2010. Available at SSRN: https://ssrn.com/abstract=1560185 or http://dx.doi.org/10.1111/j.1468-2443.2010.01105.x

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Jan Wenzelburger

Bielefeld University - Department of Business Administration and Economics ( email )

P.O. Box 100131
D-33501 Bielefeld, NRW 33501
Germany
+49 521 106 4835 (Phone)
+49 521 106 6018 (Fax)

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