The way banks internally allocate capital is an important factor in determining how changes in risk or regulation may affect the financial sector, according to a working paper published by the Bank for International Settlements.

Authors Tirupam Goel, Ulf Lewrick and Nikola Tarashev design a model whereby banks have a lending arm and a market-making arm. They find the relative efficiency of each arm affects how the bank reallocates capital in response to a change in regulation, internal risk