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Procyclicality and Regulatory Arbitrage through Optimized Internal Rating Systems
[Arbitrage réglementaire et implications procycliques des choix en matière de systèmes de notation interne]

Author

Listed:
  • Abdikarim Fouad Ali
  • Adrian Pop

    (Faculté de Droit, Economie et Gestion de l’université d’Angers., GRANEM - Groupe de Recherche Angevin en Economie et Management - UA - Université d'Angers - Institut Agro Rennes Angers - Institut Agro - Institut national d'enseignement supérieur pour l'agriculture, l'alimentation et l'environnement)

Abstract

The aim of this article is to assess the procyclical implications of the various approaches and rating philosophies used to compute minimum capital requirements while taking into account the regulatory arbitrage-seeking behavior of banks. Regulatory arbitrage is modeled through the bank's incentive to optimize its internal rating system in order to lower as much as possible the capital charge given the structure of its loan portfolio in terms of default probabilities. Our counterfactual analysis reveals that regulatory arbitrage is effective in lowering the minimum capital charge under the Internal Rating-Based (IRB) approach, but it also increases its volatility and, potentially, exacerbates the procyclicality of risk-adjusted solvency regulations.

Suggested Citation

  • Abdikarim Fouad Ali & Adrian Pop, 2024. "Procyclicality and Regulatory Arbitrage through Optimized Internal Rating Systems [Arbitrage réglementaire et implications procycliques des choix en matière de systèmes de notation interne]," Post-Print hal-04900994, HAL.
    • Handle: RePEc:hal:journl:hal-04900994
    DOI: 10.3917/reco.754.0607
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