Abstract
Using loan-level data from Germany, we investigate how the introduction of model-based capital regulation affected banks' ability to absorb shocks. The objective of this regulation was to enhance financial stability by making capital requirements responsive to asset risk. Our evidence suggests that banks “optimized” model-based regulation to lower their capital requirements. Banks systematically underreported risk, with underreporting more pronounced for banks with higher gains from it. Moreover, large banks benefitted from the regulation at the expense of smaller banks. Overall, our results suggest that sophisticated rules may have undesired effects if strategic misbehavior is difficult to detect.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 1635-1684 |
| Number of pages | 50 |
| Journal | Journal of Finance |
| Volume | 77 |
| Issue number | 3 |
| DOIs | |
| State | Published - Jun 2022 |
Funding
Markus Behn is at the European Central Bank. Rainer Haselmann is at Goethe University Frankfurt, CAS LawFin, and CEPR. Vikrant Vig is at London Business School and Kellogg School of Management. We are indebted to Editor Philip Bond and two anonymous referees. We would also like to thank Daron Acemoglu, Tobias Berg, Dion Bongaerts, Charles Calomiris, Joao Cocco, Jean‐Edouard Colliard, Hans Degryse, Charles Goodhart, Matrin Hellwig, Victoria Ivashina, Anil Kashyap, Randy Kroszner, Fred Malherbe, John Moore, Steven Ongena, Rafael Repullo, Jean‐Charles Rochet, Stephen Schaefer, Henri Servaes, Gunjan Seth, Vania Stavrakeva, Sascha Steffen, Jeremy Stein, René Stulz, Johannes Stroebel, Javier Suarez, Anjan Thakor, and Luigi Zingales, as well as seminar participants at Adam Smith Workshop London, BFI Chicago, Bonn, Cass Business School, Chicago Booth, CEMFI, CEPR Summer Symposium Gerzensee, Deutsche Bundesbank, European Central Bank, GEA, IMFS Conference Frankfurt, LBS, LSE, Max Planck Institute Bonn, NBER Summer Institute (CF/RISK, ME and CRA), Kellogg, Rotterdam, Stanford, Tilburg, Frankfurt, Leuven, and Zurich for useful comments and discussions. We are grateful to the Deutsche Bundesbank, in particular to Klaus Düllmann and Thomas Kick, for their generous support with the construction of the data set. This project received funding from the European Research Council (ERC) under the European Union's Horizon 2020 research and innovation programme (grant agreement No. 679747). The paper also benefited significantly from a fellow visit of Vig at the Center for Advanced Studies Foundations of Law and Finance funded by the German Research Foundation (DFG)—project FOR 2774. The views expressed in this paper are those of the authors and do not necessarily reflect the views of the European Central Bank or its staff. The usual disclaimer on errors also applies here. We have read disclosure policy and have no conflicts of interest to disclose. The Journal of Finance
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics