Taylor Begley writes;:  A key regulatory response to the Global Crisis has involved higher risk-weighted capital requirements. This column documents systematic under-reporting of risk by banks that gets worse when the system is under stress. Thus banks’ self-reported levels of risk are least informative in states of the world when accurate risk measurement matters the most.

Following the Global Crisis, there has been a great deal of debate surrounding the risk-taking behaviour and incentives of large, global banks and their potential consequences for the stability of the financial system. Some argue that the privately optimal level of capital for a bank may differ substantially from the socially efficient capital level (see Admati et al. 2011, Thakor 2014). As policymakers consider new micro- and macro-prudential regulations to address these problems, it is important to understand the accuracy of self-reported risk measures generated by the internal models of large banks around the globe.

The measurement of bank risk is a key foundation for both micro-prudential and macro-prudential policy. Effective regulation relies on understanding the location and size of risks in the financial sector. In this column, we highlight a strong relationship between bank capitalisation and the risk reporting behaviour of banks under the current regulatory framework. Banks with low equity capital under-report their trading book risk, and do so more severely in times of system-wide financial stress. These results suggest that banks’ self-reported risk measures are least informative precisely during periods when accurate risk measurement is most important.  Bank Risk