The limits of model-based regulation

Behn, M, Haselmann, R and Vig, V (2022) The limits of model-based regulation. Journal of Finance, 77 (3). pp. 1635-1684. ISSN 0022-1082 OPEN ACCESS


Using loan-level data from Germany, we investigate how the introduction of model-based capital regulation affected banks’ ability to absorb shocks. The objective of this regulation was to enhance financial stability by making capital requirements responsive to asset risk. Our evidence suggests that banks “optimized” model-based regulation to lower their capital requirements. Banks systematically underreported risk, with underreporting more pronounced for banks with higher gains from it. Moreover, large banks benefitted from the regulation at the expense of smaller banks. Overall, our results suggest that sophisticated rules may have undesired effects if strategic misbehavior is difficult to detect.

More Details

Item Type: Article
Date Deposited: 30 Sep 2022 15:48
Date of first compliant deposit: 28 Sep 2022
Subjects: Economic theory
Last Modified: 28 May 2024 01:50

Export and Share


Published Version - Text
  • Available under License


View details on Dimensions' website

Downloads from LBS Research Online

View details

Actions (login required)

Edit Item Edit Item