Do Financial Regulations Shape the Functioning of Financial Institutions’ Risk Management in ABS Investment?

We show that installing stronger risk management into financial institutions – a proposal widely discussed following the 2008 financial crisis – is insufficient to constrain institutions' exposure to investment with lurking risk, such as asset-backed securities. Financial regulations affect the functioning of risk management: risk management constrains institutions' exposure to risky ABS when they face mark-to-market reporting combined with capital requirements; however, this role is considerably weaker when capital requirements are combined with historical-cost-accounting. We find suggestive evidence that financial regulations affect risk management functions through promoting risk managers' efforts in uncovering ABS risk and curbing executives' incentives to take excessive risk