The
BIS issued a working paper named ‘dynamic prudential regulation: Is prompt corrective action optimal?’ The paper investigates whether reliance on book-value capital is a good policy choice and if PCA is an optimal regulatory approach.
Under hidden choice of risk, private information on returns, limited commitment by the banker and costly liquidation, the paper first characterizes the optimal incentive-feasible allocation, and then demonstrates that the optimal allocation is implementable through the combination of a risk-based deposit insurance premium and a book-value capital regulation with prompt and stochastic termination/bailout rather than deterministic termination with no bailout as in PCA. It also shows that partial termination can be used instead of stochastic termination.
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© BIS - Bank for International Settlements
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