{
  "title": "Capital Regulation and Tail Risk",
  "publication": "IMF Working Papers, August 1, 2011",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2016/12/31/capital-regulation-and-tail-risk-25152",
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  "summary": "The paper studies risk mitigation associated with capital regulation, in a context where banks may choose tail risk asserts. We show that this undermines the traditional result that high capital reduces excess risk-taking driven by limited liability.",
  "sections": [
    {
      "heading": "Summary",
      "content": "- The paper studies risk mitigation associated with capital regulation in a context where banks may choose tail risk assets.\n- Key finding: higher capital does not necessarily reduce excess risk-taking driven by limited liability; instead, it can undermine the traditional result that high capital reduces such risk-taking.\n- Additional finding: higher capital may enable banks to take more tail risk without fearing breach of the minimal capital ratio in non-tail risky project realizations.\n- The results are consistent with stylized facts about pre-crisis bank behavior and suggest implications for the optimal design of capital regulation."
    },
    {
      "heading": "Main findings and analysis",
      "content": "- Higher capital can have the unintended effect of enabling banks to increase tail risk exposure.\n- The traditional view—that higher capital reduces excess risk-taking due to limited liability—is undermined when banks can choose tail risk assets.\n- The model results align with stylized facts observed in pre-crisis bank behavior."
    },
    {
      "heading": "Policy implications and recommendations",
      "content": "- Capital regulation design should account for the possibility that increasing capital requirements could encourage selection of tail-risk projects.\n- Optimal capital regulation requires attention to banks' portfolio choices, including incentives to shift into tail risk assets when capital is higher.\n- Consideration of recapitalization costs and project-choice incentives is important for calibrating capital adequacy requirements and countercyclical capital buffers."
    },
    {
      "heading": "Research context and scope",
      "content": "- Subject areas: Bank regulation; Banking; Capital adequacy requirements; Countercyclical capital buffers; Financial crises; Financial regulation and supervision; Tax incentives.\n- Keywords: adjustment cost; adjustment effect; bank capital; Bank regulation; Capital adequacy requirements; capital ratio; Capital Regulation; capital requirement; Countercyclical capital buffers; Financial Innovation; project choice; recapitalization cost; recapitalization decision; Risk Management; risk profile; Tail Risk; WP.\n\n---\n\n Content in this bundle\n\n- wp11188\n  - wp11188 (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - wp11188 (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2016/12/31/capital-regulation-and-tail-risk-25152"
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    "Authors: Enrico Camillo Perotti, Lev Ratnovski, Razvan Vlahu",
    "Published: August 1, 2011",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781462308262.001",
    "The paper studies risk mitigation associated with capital regulation in a context where banks may choose tail risk assets.",
    "Key finding: higher capital does not necessarily reduce excess risk-taking driven by limited liability; instead, it can undermine the traditional result that high capital reduces such risk-taking.",
    "Additional finding: higher capital may enable banks to take more tail risk without fearing breach of the minimal capital ratio in non-tail risky project realizations.",
    "The results are consistent with stylized facts about pre-crisis bank behavior and suggest implications for the optimal design of capital regulation.",
    "Higher capital can have the unintended effect of enabling banks to increase tail risk exposure.",
    "The traditional view—that higher capital reduces excess risk-taking due to limited liability—is undermined when banks can choose tail risk assets.",
    "The model results align with stylized facts observed in pre-crisis bank behavior.",
    "Capital regulation design should account for the possibility that increasing capital requirements could encourage selection of tail-risk projects.",
    "Optimal capital regulation requires attention to banks' portfolio choices, including incentives to shift into tail risk assets when capital is higher.",
    "Consideration of recapitalization costs and project-choice incentives is important for calibrating capital adequacy requirements and countercyclical capital buffers.",
    "Subject areas: Bank regulation; Banking; Capital adequacy requirements; Countercyclical capital buffers; Financial crises; Financial regulation and supervision; Tax incentives.",
    "Keywords: adjustment cost; adjustment effect; bank capital; Bank regulation; Capital adequacy requirements; capital ratio; Capital Regulation; capital requirement; Countercyclical capital buffers; Financial Innovation; project choice; recapitalization cost; recapitalization decision; Risk Management; risk profile; Tail Risk; WP.",
    "**_wp11188**"
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