Working Paper: NBER ID: w19257
Authors: Bo Becker; Marcus Opp
Abstract: We analyze a reform of insurance companies' capital requirements for mortgage-backed securities. First, credit ratings were replaced as inputs to capital regulation. Second, the redesigned system ensures capital buffers sufficient to withstand expected losses, but insufficient to protect against adverse outcomes. Many bonds are now treated as riskless and require minimal capital. By 2012, aggregate capital requirements for mortgage-backed securities have been reduced from $19.36bn (had the previous system been maintained) to $3.73bn. Exploiting that the change did not affect other asset classes, we document that insurers' risk taking was distorted and increased in response to the new regulation.
Keywords: capital requirements; mortgage-backed securities; insurance; financial regulation
JEL Codes: G22; G24; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Regulatory reform (L51) | Insurers' risk exposure in new acquisitions of mortgage-backed securities (MBS) (G52) |
| Regulatory reform (L51) | Shift in portfolio allocations towards riskier structured securities (G11) |
| New capital requirements (G28) | Increased risk-taking behavior of insurers (G52) |
| New capital requirements (G28) | Flows towards favorably treated securities (G12) |
| Regulatory reform (L51) | Increased systemic risk in the insurance industry (G22) |