TY  - JOUR
AU  - Pelizzon,Loriana
AU  - Schaefer,Stephen
TI  - Pillar 1 vs. Pillar 2 Under Risk Management
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 11666
PY  - 2005
Y2  - October 2005
UR  - http://www.nber.org/papers/w11666
L1  - http://www.nber.org/papers/w11666.pdf
N1  - Author contact info:
Loriana Pelizzon
University of Venice
Department of Economics
Cannareggio 873
Venice, 30100 ITALY
E-Mail: pelizzon@unive.it

Stephen Schaefer
London Business School
Regents Park
London, NW14SA
United Kingdom
E-Mail: sschaefer@london.edu
M2  - featured in NBER digest on 2005-10-03
AB  - Under the New Basel Accord bank capital adequacy rules (Pillar 1) are substantially revised but the introduction of two new "Pillars" is, perhaps, of even greater significance. This paper focuses on Pillar 2 which expands the range of instruments available to the regulator when intervening with banks that are capital inadequate and investigates the complementarity between Pillar 1 (risk-based capital requirements) and Pillar 2. In particular, the paper focuses on the role of closure rules when recapitalization is costly. In the model banks are able to manage their portfolios dynamically and their decisions on recapitalization and capital structure are determined endogenously. A feature of our approach is to consider the costs as well as the benefits of capital regulation and to accommodate the behavioral response of banks in terms of their portfolio strategy and capital structure. The paper argues that problems of capital adequacy are minor unless, in at least some states of the world, banks are able to violate the capital adequacy rules. The paper shows how the role of Pillar 2 depends on the effectiveness of capital regulation, i.e., the extent to which banks can "cheat".
ER  -