Working Paper: CEPR ID: DP6353
Authors: Hans Gersbach; Jan Wenzelburger
Abstract: We investigate the question of whether sophistication in risk management fosters banking stability. We compare a simple banking system in which an average rating is used with a sophisticated banking system in which banks are able to assess the default risk of entrepreneurs individually. Both banking systems compete for deposits, loans, and bank equity. While a sophisticated system rewards entrepreneurs with low default risks by low loan interest rates, a simple system acquires more bank equity and finances more entrepreneurs. Expected repayments in a simple system are always higher and its default risk is lower if productivity is sufficiently high. Expected aggregate consumption of entrepreneurs, however, is higher in a sophisticated banking system.
Keywords: banking regulation; financial intermediation; macroeconomic risks; rating; risk management; risk premia
JEL Codes: D40; E44; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sophistication in risk management (D81) | banking stability (F65) |
| sophisticated banking system (G21) | higher default risks (G32) |
| simple banking system (G21) | higher expected repayments (G51) |
| simple banking system (G21) | lower default risks (G32) |
| sophistication in risk assessment (D81) | expected aggregate consumption (E20) |
| sophistication in risk management (D81) | systemic vulnerabilities (P34) |
| sophistication in risk management (D81) | distributional effects (D39) |