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Rules, Standards, and Complexity in the Cost Benefit Analysis of Capital Regulation

Rules, Standards, and Complexity in the Cost Benefit Analysis of Capital Regulation, Prasad Krishnamurthy - U.C. Berkeley School of Law; University of California, Berkeley – School of Law, Berkeley Center for Law, Business and the Economy; University of California, Berkeley, December 1, 2013. Journal of Legal Studies, Forthcoming.

“This article considers whether cost-benefit analysis can inform two important issues in the capital regulation of banks: (1) the choice of a rule or standard and (2) the level of complexity in that rule or standard. I analyze these issues by examining the historical adoption of minimum capital requirements and risk-based capital requirements. I argue that simple, minimum capital requirements are most useful when regulators seek to manage poorly understood risks with large externalities. I argue that risk-weighted capital requirements are most useful when regulators face well-understood risks while acting as agents of ordinary bank creditors. I suggest how these principles can help inform regulatory decision-making in the face of uncertainty over the cost of capital regulation.”

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