Template-Type: ReDIF-Paper 1.0
Author-Name: Tirupam Goel
Author-X-Name-First: Tirupam
Author-X-Name-Last: Goel
Author-Name: Isha Agarwal
Author-X-Name-First: Isha
Author-X-Name-Last: Agarwal
Title: Limits of stress-test based bank regulation
Abstract: Supervisory risk assessment tools, such as stress-tests, provide complementary information about bank-specific risk exposures. Recent empirical evidence, however, underscores the potential inaccuracies inherent in such assessments. We develop a model to investigate the regulatory implications of these inaccuracies. In the absence of such tools, the regulator sets the same requirement across banks. Risk assessment tools provide a noisy signal about banks' types, and enable bank specific capital surcharges, which can improve welfare. Yet, a noisy assessment can distort banks' ex ante incentives and lead to riskier banks. The optimal surcharge is zero when assessment accuracy is below a certain threshold, and increases with accuracy otherwise.
Length: 56 pages
Creation-Date: 2021-07
File-URL: https://www.bis.org/publ/work953.pdf
File-Format: Application/pdf
File-Function: Full PDF document
File-URL: https://www.bis.org/publ/work953.htm
File-Format: text/html
Number: 953
Keywords: capital regulation; stress-tests; information asymmetry; adverse incentives; disclosure policy; Covid-19
Classification-JEL: G21, G28, C61
Handle: RePEc:bis:biswps:953