The Federal Reserve Board published a research paper, “Regulating Bank Portfolio Choice Under Asymmetric Information,” modelling how regulators can curb bank risk-taking when banks have superior information about portfolio risk and can adjust behaviour in response to rules, with the analysis focusing on tax-based instruments. The model treats taxes as a flexible stand-in for multiple regulatory tools, including as a proxy for the shadow costs of requirements such as capital regulation. It concludes that linear risk-sensitive taxes should not generally be set more conservatively simply to offset asymmetric information, and highlights three tools that can improve efficacy: withholding tax schedules from banks until after portfolio selection, using nonlinear taxes that react to information revealed by portfolio choice, and taxing realised profits to encourage banks to reduce risk.
Federal Reserve Board 2025-02-24
Federal Reserve Board research finds linear risk-sensitive taxes need not be tightened under asymmetric information and outlines alternative tools
The Federal Reserve Board released a paper titled “Regulating Bank Portfolio Choice Under Asymmetric Information,” exploring strategies to mitigate bank risk-taking when banks have superior information about portfolio risk. The study suggests using tax-based instruments as flexible tools and recommends withholding tax schedules, employing nonlinear taxes, and taxing realised profits to enhance regulatory effectiveness.