NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Regulatory reform and risk-taking: replacing ratings

Bo Becker, Marcus Opp

NBER Working Paper No. 19257
Issued in July 2013
NBER Program(s):   CF

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.

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This paper was revised on September 4, 2014

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Document Object Identifier (DOI): 10.3386/w19257

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