DP6353 Sophistication in Risk Management, Bank Equity, and Stability
|Author(s):||Hans Gersbach, Jan Wenzelburger|
|Publication Date:||June 2007|
|Keyword(s):||banking regulation, Financial intermediation, macroeconomic risks, rating, risk management, risk premia|
|JEL(s):||D40, E44, G21|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=6353|
We investigate the question of whether sophistication in risk management fosters banking stability. We compare a simple banking system in which an average rating is used with a sophisticated banking system in which banks are able to assess the default risk of entrepreneurs individually. Both banking systems compete for deposits, loans, and bank equity. While a sophisticated system rewards entrepreneurs with low default risks by low loan interest rates, a simple system acquires more bank equity and finances more entrepreneurs. Expected repayments in a simple system are always higher and its default risk is lower if productivity is sufficiently high. Expected aggregate consumption of entrepreneurs, however, is higher in a sophisticated banking system.