Internal Models-Based Capital Regulation and Bank Risk-Taking Incentives

Author/Editor:

Paul H. Kupiec

Publication Date:

July 1, 2002

Electronic Access:

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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:

Advocates for internal model-based capital regulation argue that this approach will reduce costs and remove distortions that are created by rules-based capital regulations. These claims are examined using a Merton-style model of deposit insurance. Analysis shows that internal model-based capital estimates are biased by safety-net-generated funding subsidies that convey to bank shareholders when market and credit risk regulatory capital requirements are set using bank internal model estimates. These subsidies are not uniform across the risk spectrum, and, as a consequence, internal model regulatory capital requirements will cause distortions in bank lending behavior.

Series:

Working Paper No. 02/125

Subject:

English

Publication Date:

July 1, 2002

ISBN/ISSN:

9781451854831/1018-5941

Stock No:

WPIEA1252002

Format:

Paper

Pages:

32

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