Risk-Insensitive Regulation

38 Pages Posted: 31 Aug 2016 Last revised: 10 Apr 2018

See all articles by Alexander Bleck

Alexander Bleck

University of British Columbia - Sauder School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2017

Abstract

Banking is risky and prone to failure. Yet banking regulation is surprisingly not all that risk-sensitive in practice. I show that when the bank has an informational advantage over the regulator, designing risk-sensitive banking regulation gives rise to a trade-off: relying on the banking market for information to refine regulation improves bank risk-taking but also aggravates the market’s allocative failure and could undermine its informativeness. This tension could explain why Basel capital regulations and deposit insurance are often coarse or risk-insensitive. Paradoxically, as market frictions become more severe, optimal regulation becomes ever more risk-insensitive. Only risk-insensitive regulation necessitates a system-wide approach.

Keywords: Bank capital regulation, risk-taking, systemic risk, mechanism design

JEL Classification: D61, D62, D82, G21, G28

Suggested Citation

Bleck, Alexander, Risk-Insensitive Regulation (February 1, 2017). Sauder School of Business Working Paper, 2nd Annual Financial Institutions, Regulation and Corporate Governance Conference, Available at SSRN: https://ssrn.com/abstract=2832554 or http://dx.doi.org/10.2139/ssrn.2832554

Alexander Bleck (Contact Author)

University of British Columbia - Sauder School of Business ( email )

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