IMF Working Papers

Internal Models-Based Capital Regulation and Bank Risk-Taking Incentives

By Paul H. Kupiec

July 1, 2002

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Format: Chicago

Paul H. Kupiec "Internal Models-Based Capital Regulation and Bank Risk-Taking Incentives", IMF Working Papers 2002, 125 (2002), accessed April 18, 2025, https://doi.org/10.5089/9781451854831.001

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

Advocates for internal model-based capital regulation argue that this approach will reduce costs and remove distortions that are created by rules-based capital regulations. These claims are examined using a Merton-style model of deposit insurance. Analysis shows that internal model-based capital estimates are biased by safety-net-generated funding subsidies that convey to bank shareholders when market and credit risk regulatory capital requirements are set using bank internal model estimates. These subsidies are not uniform across the risk spectrum, and, as a consequence, internal model regulatory capital requirements will cause distortions in bank lending behavior.

Subject: Banking, Bonds, Credit risk, Insurance, Market risk

Keywords: Market value, WP

Publication Details

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