PUB - Publikationen an der Universität Bielefeld

We investigate the question of whether sophistication in risk management fosters banking stability. We compare a simple banking system in which an average rating is used with a sophisticated banking system in which banks are able to assess the default risk of entrepreneurs individually. Both banking systems compete for deposits, loans, and equity. While a sophisticated system rewards entrepreneurs with low default risks by low loan interest rates, a simple system acquires more equity and finances more entrepreneurs. Expected repayments in a simple system are always higher and its default risk is lower if productivity is sufficiently high.