A real options approach for evaluating the implementation of a risk sensitive capital rule in banks

I evaluate a bank’s incentives to implement a risk sensitive regulatory capital rule. The decision making is analyzed within a real options framework where optimal policies are derived in terms of threshold levels of risk. The bank’s customers, lenders, and other outsiders may influence the optimal decision. Outsiders may make it optimal for the bank to implement the risk sensitive rule earlier than it otherwise would have preferred. I provide numerical example for the implementation of internal rating based models for credit risk (the IRB-approach) under the new Basel accord (Basel II). JEL classification: G13; G21; G28; G32