Optimal Prudential Regulation of Banks and the Political Economy of Supervision

May 28, 2014

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Format: Chicago

Thierry Tressel, and Thierry Verdier. Optimal Prudential Regulation of Banks and the Political Economy of Supervision, (USA: International Monetary Fund, 2014) accessed September 19, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

We consider a moral hazard economy in banks and production to study how incentives for risk taking are affected by the quality of supervision. We show that low interest rates may generate excessive risk taking. Because of a pecuniary externality, the market equilibrium may not be optimal and there is a need for prudential regulation. We show that the optimal capital ratio depends on the macro-financial cycle, and that, in presence of production externalities, it should be complemented by a constraint on asset allocation. We show that the political process tends to exacerbate excessive risk taking and credit cycles.

Subject: Auditing, Bank supervision, Banking, Capital adequacy requirements, Financial regulation and supervision, Labor, Public financial management (PFM), Regulatory forbearance, Self-employment

Keywords: Adequacy rule, Auditing, Bank audit, Bank capital, Bank supervision, Bank supervisor, Banking Regulation, Banking supervision, Capital adequacy ratio, Capital adequacy requirements, Expected return, Global, Incentive constraint, Political Economy, Regulatory Forbearance, Self-employment, WP

Publication Details

Pages:

61
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2014/090
Stock No:

WPIEA2014090
ISBN:

9781498338554
ISSN:

1018-5941

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