Capital regulation induced reaching for systematic yield: Financial instability through fire sales

Martijn Adriaan Boermans, Bram van der Kroft

Research output: Working paper / PreprintWorking paper


We investigate whether the omission of systematic risk in rating-based capital regulation induces strategic bond portfolio allocations that decrease financial stability. Capital regulation does not constrain systematic risk-taking by using credit ratings. We verify that this incentivizes banks and insurance corporations to hoard bonds with excessive systematic risk using a confidential bond-level holdings dataset of the ECB. Our findings highlight three interconnected channels through which this systematic risk-taking reduces financial stability by increasing the likelihood and severity of fire sales. Therefore, omitting systematic risk in capital regulation increases the fragility of the financial sector, especially in economic downturns.
Original languageEnglish
PublisherDe Nederlandsche Bank
Publication statusPublished - 13 Feb 2020

Publication series

SeriesDe Nederlandsche Bank Working Papers

JEL classifications

  • g11 - "Portfolio Choice; Investment Decisions"
  • g21 - "Banks; Depository Institutions; Micro Finance Institutions; Mortgages"
  • g22 - "Insurance; Insurance Companies"
  • g24 - "Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies"
  • g28 - Financial Institutions and Services: Government Policy and Regulation


  • Inflated credit ratings
  • capital requirements
  • regulatory arbitrage
  • Basel III
  • Solvency II
  • portfolio choice
  • securities holdings statistics

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