ECB published a working paper that analyzes the effect of bank capital requirements on the structure and risk of a financial system where markets, regulated banks, and shadow banks coexist. The issues addressed in the paper include the difference between regulated and shadow banks in the context of direct market finance; the type of borrowers funded by these institutions; the ways in which bank capital regulation affects lending through these channels; and the impact of the existence of shadow banks on the effectiveness of Basel III.
The paper presents the model of bank lending under moral hazard in which banks are not regulated and have to pay a cost to certify their capital. The paper analyzes the effects of flat and Value-at-Risk (VaR) requirements on the structure and risk of the financial system. It also characterizes optimal capital requirements and considers the effect of changes in funding costs and of endogenizing the cost of capital. Appendix A shows that the qualitative results remain unchanged when the advantage of regulated banks relative to shadow banks comes from the existence of underpriced deposit insurance. Appendix B contains the proofs of the analytical results.
The analysis shows how tighter risk-insensitive (sensitive) capital requirements can lead to a shift of intermediate (high) risk entrepreneurs from regulated to unregulated finance. This results in an increase in the default probability of entrepreneurs that shift and, therefore, in an unintended consequence of capital regulation that can lead to a riskier financial system. The analysis also reveals the ways in which optimal capital regulation must consider the existence of unregulated finance, whose presence imposes a constraint on the regulator, which leads to lower optimal capital requirements.
Related Link: ECB Working Paper (PDF)
Keywords: Europe, EU, Banking, Basel III, Shadow Banking, Capital Requirements, Credit Risk, ECB
A well-recognized researcher in the field; offers many years of experience in the real estate ﬁnance industry, and leads research efforts in expanding credit risk analytics to commercial real estate.
Previous ArticleECB Publishes Results of the 2018 Stress Test for Banks
APRA announced the standardization of quarterly reporting due dates for authorized deposit-taking institutions.
Bundesbank published a list of "EntryPoints" that are accepted in its reporting system; the list provides taxonomy version and name of the module against each EntryPoint.
The private sector working group of ECB on euro risk-free rates published the recommendations to address events that would trigger fallbacks in the Euro Interbank Offered Rate (EURIBOR)-related contracts, along with the €STR-based EURIBOR fallback rates (rates that could be used if a fallback is triggered).
EBA published the phase 1 of its reporting framework 3.1, with the technical package covering the new reporting requirements for investment firms (under the implementing technical standards on investment firms reporting).
Asia Pacific Australia Banking APS 111 Capital Adequacy Regulatory Capital Basel RBNZ APRA
ESMA published the final guidelines on outsourcing to cloud service providers.
EBA published annual data for two key concepts and indicators in the Deposit Guarantee Schemes (DGS) Directive—available financial means and covered deposits.
OSFI has set out the schedule for release of draft guidance on the management of technology risks by federally regulated financial institutions and private pension plans.
MAS updated rules for new housing loans by banks and finance companies.
HKMA published a statement on the 100% Personal Loan Guarantee Scheme and a guideline on the Green and Sustainable Finance Grant Scheme (GSF Grant Scheme) as announced in the 2021-22 Budget.