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Tail risk, capital requirements and the internal agency problem in banks


Klimenko, Nataliya (2014). Tail risk, capital requirements and the internal agency problem in banks. s.n. s.n., University of Zurich.

Abstract

This paper shows how to design incentive-based capital requirements that would prevent the bank from manufacturing tail risk. In the model, the senior bank manager may have incentives to engage in tail risk. Bank shareholders can prevent the manager from taking on tail risk via the optimal incentive compensation contract. To induce shareholders to implement this contract, capital requirements should internalize its costs. Moreover, bank shareholders must be given the incentives to comply with minimum capital requirements by raising new equity and expanding bank assets. Making bank shareholders bear the costs of compliance with capital regulation turns out to be crucial for motivating them to care about risk-management quality in their bank.

This paper shows how to design incentive-based capital requirements that would prevent the bank from manufacturing tail risk. In the model, the senior bank manager may have incentives to engage in tail risk. Bank shareholders can prevent the manager from taking on tail risk via the optimal incentive compensation contract. To induce shareholders to implement this contract, capital requirements should internalize its costs. Moreover, bank shareholders must be given the incentives to comply with minimum capital requirements by raising new equity and expanding bank assets. Making bank shareholders bear the costs of compliance with capital regulation turns out to be crucial for motivating them to care about risk-management quality in their bank.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:22 April 2014
Deposited On:05 May 2014 16:01
Last Modified:05 Apr 2016 17:51
Series Name:s.n.
Other Identification Number:merlin-id:9353
Permanent URL: https://doi.org/10.5167/uzh-95537

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