Regulating a Model

Yaron Leitner &
Bilge Yilmaz

Revised May 2018

WP 16-31/R - We study a situation in which a regulator relies on risk models that banks produce in order to regulate them. A bank can generate more than one model and choose which models to reveal to the regulator.

A previous version of this working paper was originally published in November 2016.

The regulator can find out the other models by monitoring the bank, but in equilibrium, monitoring induces the bank to produce less information. We show that a high level of monitoring is desirable when the bank’s private gain from producing more information is either sufficiently high or sufficiently low. When public models are more precise, banks produce more information, but the regulator may end up monitoring more.

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