Bank Capital Regulation with an Opportunistic Rating Agency

46 Pages Posted: 18 Jun 2013

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)

Multiple version iconThere are 2 versions of this paper

Date Written: June 17, 2013

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: D820, G210, G240, G280

Suggested Citation

Efing, Matthias, Bank Capital Regulation with an Opportunistic Rating Agency (June 17, 2013). CESifo Working Paper Series No. 4267. Available at SSRN: https://ssrn.com/abstract=2280292

Matthias Efing (Contact Author)

HEC Paris - Finance Department ( email )

France
(++33)695646755 (Phone)

HOME PAGE: http://matthiasefing.com/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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