Corporate Risk Management

CHAPTER 9Regulation of Bank Risk and Use of VaR

Banks have been regulated for many years. This chapter discusses the regulation of bank risk rather than that of competition between banks. Even if some risks affect shareholders and banks' creditors, this does not justify regulation because these agents are compensated for the risks they take and have access to monitoring instruments that give them sufficient information to protect themselves. In addition, these actors can diversify their portfolios at costs lower than those incurred by other banks partners.

In contrast, deposit holders do not necessarily have access to the same private monitoring instruments and to the same diversification possibilities. Notably, private information on banks' default costs are lower for shareholders and creditors, who have direct access to some information. An inexpensive way to monitor a bank is to buy its stock. Investors thus receive quarterly and annual reports, and can attend shareholder meetings. However, this information may not be sufficient. It is better to be a board member!

It is crucial to keep in mind that small savers have fewer diversification options than shareholders, creditors, and bank managers. In addition, deposits are traditionally recognized or described as risk-free assets. Deposit insurance was introduced in several countries to protect depositors. However, this insurance may have generated ex ante moral hazard and induced risk-taking behavior in bank managers that does ...