RISK-BASED CAPITAL REQUIREMENTS AND BANK PORTFOLIO RISK

We construct a linear programming model and analyze the effectiveness of R-B capital adequacy standards when bank deposits are fully insured. We derive a set of optimal asset risk weights. Given a constraint in raising equity and using these weights, the R-B capital plan is an effective regulation mechanism. Without a constraint on equity, maximum leverage restrictions and R-B capital plans are mutually exclusive alternatives. As we deviate from the optimal risk weights, a combination of a leverage restriction and a R-B equity ratio seems to be the more appropriate approach to controlling bank portfolio risk.