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The Risks of Financial Institutions$
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Mark Carey and Rene M. Stulz

Print publication date: 2007

Print ISBN-13: 9780226092850

Published to Chicago Scholarship Online: February 2013

DOI: 10.7208/chicago/9780226092980.001.0001

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PRINTED FROM CHICAGO SCHOLARSHIP ONLINE (www.chicago.universitypressscholarship.com). (c) Copyright University of Chicago Press, 2021. All Rights Reserved. An individual user may print out a PDF of a single chapter of a monograph in CHSO for personal use.date: 17 September 2021

Pillar 1 versus Pillar 2 under Risk Management

Pillar 1 versus Pillar 2 under Risk Management

Chapter:
(p.377) 8 Pillar 1 versus Pillar 2 under Risk Management
Source:
The Risks of Financial Institutions
Author(s):

Loriana Pelizzon

Stephen Schaefer

Publisher:
University of Chicago Press
DOI:10.7208/chicago/9780226092980.003.0009

This chapter explores the consequences of adding Pillar 2 alongside Pillar 1 in terms of bank risk taking and the scale of bank lending. It also concentrates on the interaction between Pillar 1 and Pillar 2 when banks are able to use risk management to cheat in relation to capital requirements. The disciplinary effect of the franchise value vanishes when closure rules allow costless recapitalization. The presence of costs of recapitalization decreases the cost of deposit insurance but increases the probability of default. Without Pillar 2/Prompt Corrective Action (PCA), even when banks' compliance is relatively good (limited cheating), risk-based capital regulation (RBCR) may be effective in the sense that, for higher levels of RBCR, banks do indeed hold higher amounts of capital. Pillar 2/PCA is most effective in decreasing the cost of deposit insurance when compliance is relatively poor.

Keywords:   Pillar 2, Pillar 1, bank risk, bank lending, risk management, capital requirements, recapitalization, capital regulation, deposit insurance, Prompt Corrective Action

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