Abstract - Bank Size and Risk-Taking under Basel II

This paper discusses the relationship between bank size and risk-taking
under Pillar I of the New Basel Capital Accord. Using a model with imperfect
competition and moral hazard, we find that small banks (and hence small borrowers)
may profit from the introduction of an internal ratings based (IRB) approach if this
approach is applied uniformly across banks. However, the banks’ right to choose
between the standardized and the IRB approaches unambiguously hurts small banks,
and pushes them towards higher risk-taking due to fiercer competition. This may
even lead to higher aggregate risk in the economy.

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