DP7524 Regulatory Competition and Bank Risk Taking

Author(s): Itai Agur
Publication Date: October 2009
Keyword(s): Arbitrage, Bank default, Interbank market, Moral hazard, Supervision
JEL(s): G21, G28
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7524

How damaging is competition between bank regulators? This paper models regulators that compete because they want to supervise more banks. Both banks' risk profiles and their access to wholesale funding are endogenous, leading to rich interactions. The sensitivity of regulatory standards to bank moral hazard, adverse selection, liquidity risk and the degree of regulatory bias is investigated. A calibration suggests that regulatory reform can halve bank default rates. The paper also shows how a decline in regulators' monitoring capacity gives rise to a gradual rise in bank risk, followed by a sudden interbank crisis.