Refined Risk Assessment and Banking Stability

ETH Risk Center – Working Paper Series ETH-RC-13-005

41 Pages Posted: 10 Jan 2014

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

University of Liverpool - Management School (ULMS)

Date Written: August 2013

Abstract

Current banking regulatory frameworks are based on the belief that refined assessment of credit risks improves banking stability. This paper investigates this claim in a general setting by comparing a simple banking system with a sophisticated banking system which is capable of assessing default risks of entrepreneurs more accurately. By charging actuarially fair loan-interest rates, the sophisticated system finances fewer entrepreneurs. Relative to the simple system, both their repayments and liabilities are lower. Expected aggregate profits of entrepreneurs are higher but consumers receive lower deposit rates. Refined risk assessment may increase the systemic default risk of a banking system if bank equity is too low. Requiring higher bank equity ratios and forcing banks to refine their risk assessment techniques tend to increase stability if taken together, but may not be successful if only the latter is implemented. We draw implications for the policy debate, sparked by the financial crisis.

Keywords: financial intermediation, macroeconomic risks, risk assessment, risk premiums, banking regulation, rating

JEL Classification: D40, E44, G21

Suggested Citation

Gersbach, Hans and Wenzelburger, Jan, Refined Risk Assessment and Banking Stability (August 2013). ETH Risk Center – Working Paper Series ETH-RC-13-005. Available at SSRN: https://ssrn.com/abstract=2376370 or http://dx.doi.org/10.2139/ssrn.2376370

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

University of Liverpool - Management School (ULMS) ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

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