Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/104592
Authors: 
Behn, Markus
Haselmann, Rainer
Vig, Vikrant
Year of Publication: 
2014
Series/Report no.: 
SAFE Working Paper Series 75
Abstract: 
In this paper, we investigate how the introduction of complex, model-based capital regulation affected credit risk of financial institutions. Model-based regulation was meant to enhance the stability of the financial sector by making capital charges more sensitive to risk. Exploiting the staggered introduction of the model-based approach in Germany and the richness of our loan-level data set, we show that (1) internal risk estimates employed for regulatory purposes systematically underpredict actual default rates by 0.5 to 1 percentage points; (2) both default rates and loss rates are higher for loans that were originated under the model-based approach, while corresponding risk-weights are significantly lower; and (3) interest rates are higher for loans originated under the model-based approach, suggesting that banks were aware of the higher risk associated with these loans and priced them accordingly. Further, we document that large banks benefited from the reform as they experienced a reduction in capital charges and consequently expanded their lending at the expense of smaller banks that did not introduce the model-based approach. Counter to the stated objectives, the introduction of complex regulation adversely affected the credit risk of financial institutions. Overall, our results highlight the pitfalls of complex regulation and suggest that simpler rules may increase the efficacy of financial regulation.
Subjects: 
capital regulation
internal ratings
Basel regulation
JEL: 
G01
G21
G28
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

Files in This Item:
File
Size
639.95 kB





Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.