Loan-Portfolio Quality and the Diffusion of Technological
Innovation ∗
Robert Hauswald Robert Marquez
American University University of Maryland
Current Version March 2004
Working Paper 2004-02
JEL Classification: G21, L51, O31
∗We would like to thank Haluk Unal for stimulating our interest in this area, and Rosalind Bennett, Andrew
Davenport, Ulrich Hege, Dan Nuxoll, Michel Robe, and seminar participants at the FDIC and American University
for suggestions that helped improve the paper. The research leading to this paper was undertaken while the authors
were visiting the FDIC, whose hospitality and financial support is gratefully acknowledged. Part of this work was
completed while Marquez was visiting the Wharton School of Business. The usual disclaimers apply. Contact
information: Robert Marquez, R. H. Smith School of Business, University of Maryland, College Park, MD 20742,
rmarquez@rhsmith.umd.edu, and Robert Hauswald, Kogod School of Business, American University, Washington, DC
20016, hauswald@american.edu.
Innovation ∗
Robert Hauswald Robert Marquez
American University University of Maryland
Current Version March 2004
Working Paper 2004-02
JEL Classification: G21, L51, O31
∗We would like to thank Haluk Unal for stimulating our interest in this area, and Rosalind Bennett, Andrew
Davenport, Ulrich Hege, Dan Nuxoll, Michel Robe, and seminar participants at the FDIC and American University
for suggestions that helped improve the paper. The research leading to this paper was undertaken while the authors
were visiting the FDIC, whose hospitality and financial support is gratefully acknowledged. Part of this work was
completed while Marquez was visiting the Wharton School of Business. The usual disclaimers apply. Contact
information: Robert Marquez, R. H. Smith School of Business, University of Maryland, College Park, MD 20742,
rmarquez@rhsmith.umd.edu, and Robert Hauswald, Kogod School of Business, American University, Washington, DC
20016, hauswald@american.edu.
Loan-Portfolio Quality and the Diffusion
of Technological Innovation
Abstract
We study the economic forces that drive innovation in credit-risk assessment and the role of reg-
ulators in fostering technological progress. Recent regulatory proposals base capital-adequacy
standards on banks’ own internal systems and call for regulators to establish a set of “best
practices” for the industry. We find that the dissemination of innovations mandated by this
approach generates a tension between lowering aggregate banking-system risk ex post and pro-
viding banks with incentives to innovate ex ante. Moreover, this tension arises purely from
regulatory concern for bank safety and not from any interest in promoting competition. We
show that achieving the optimal level of innovation requires that regulators restrict the diffusion
of technology. If regulators are unable to commit to specific dissemination policies, it may be
beneficial to let banks assert intellectual property rights through, for instance, the patenting of
their innovations.
of Technological Innovation
Abstract
We study the economic forces that drive innovation in credit-risk assessment and the role of reg-
ulators in fostering technological progress. Recent regulatory proposals base capital-adequacy
standards on banks’ own internal systems and call for regulators to establish a set of “best
practices” for the industry. We find that the dissemination of innovations mandated by this
approach generates a tension between lowering aggregate banking-system risk ex post and pro-
viding banks with incentives to innovate ex ante. Moreover, this tension arises purely from
regulatory concern for bank safety and not from any interest in promoting competition. We
show that achieving the optimal level of innovation requires that regulators restrict the diffusion
of technology. If regulators are unable to commit to specific dissemination policies, it may be
beneficial to let banks assert intellectual property rights through, for instance, the patenting of
their innovations.