Keywords: Bank capital, market risk, incentive regulation
Abstract: This paper develops a model of bank behavior that focuses on the
interaction between the incentives created by fixed-rate deposit
insurance and a bank's choice of its loan portfolio and its
market-traded financial instruments. The model is used to analyze the
consequences of the Federal Reserve Board's proposed pre-commitment
approach (PCA) for setting market risk capital requirements for bank
trading portfolios. Under the PCA, a bank determines its own market
risk capital requirement and is subject to a known regulatory penalty
should its trading activities generate subsequent losses that exceed
its market risk capital commitment.
Full paper (570 KB PDF)
| Full paper (535 KB Postscript)
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Last update: July 16, 1997