Abstract
A simple model of bank behaviour is shown to have implications for solvency regulation of the Basel type. The investment division seeks to maximize RORAC, with higher solvency S lowering the cost of refinancing but tying costly capital. In period 1, exogenous changes in expected returns d[Formula: see text] and in volatility d[Formula: see text] occur, causing optimal adjustments dS*/ d[Formula: see text] and dS*/ d[Formula: see text] in period 2. In period 3, the actual adjustment dS* creates an endogenous trade-off with slope d[Formula: see text]/ d[Formula: see text]. Basel-type regulation modifies this slope, inducing senior management to opt for a higher value of σ in several situations. Solvency regulation can thus run counter its stated objective.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
