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We identify and measure the impact of inefficient LJC systems on Loss Given Default (LGD). Becaus... more We identify and measure the impact of inefficient LJC systems on Loss Given Default (LGD). Because LGD is a key risk component of the new framework to measure capital adequacy, this document explains how an inefficient judiciary system, a poor body of property and legal rights or a slow and costly collateral collection procedure may add an implicit charge in capital. In this sense, Basel II should play an additional role in promoting institutional reforms in developing countries to guarantee financial stability and soundness. By using data related to legal restrictions in doing businesses for a large set of countries, we find strong evidence that improving LJC systems reduces the LGD making the impact of implementation Basel II less challenging.
The paper develops a methodology for the creation of an index of banking system's vulnerability t... more The paper develops a methodology for the creation of an index of banking system's vulnerability that can be used, as an early warning system, to assess the soundness of banking systems in developing countries. This index is based on the weighted-by-assets probability of banks classified as unsound by the supervisory agency. Applying the index for the case of Peru, it is shown that the index provides more relevant information, in advance, about the fragility of the banking system than failure models. We found that the determinants of banks' weaknesses are individual risks taken by financial institutions and external economic risks. The latter also help to determine the period of time before a bank is declared unsound. We also conclude that the banking system fragility's index in the case of Peru has a feedback causality with the economic activity, and they are negatively correlated. This result makes a case for banking regulation.
A Practical Example of the Nonperforming Loans Projection Approach to Stress Testing
approach to stress testing was deemed appropriate. Th e approach presented in this chapter is rel... more approach to stress testing was deemed appropriate. Th e approach presented in this chapter is relatively straightforward compared with modeling techniques used to assess more Th is chapter describes the features of a stress testing model that was developed for a small open economy with a relatively large banking sector. As most banks in the sector follow a traditional intermediation model focused on lending and bank CHAPTER 30
This paper analyzes, in an emerging market context, the effects of financial frictions and bank p... more This paper analyzes, in an emerging market context, the effects of financial frictions and bank prudential regulation on the business cycle. It also proposes a prudential rule that smoothes the external finance premium, and at the same time, improves the effectiveness of the monetary policy. I hypothesize that the macroeconomic effects of bank capital requirements are procyclical and lead to the amplification of monetary shocks, therefore reducing their effectiveness for fighting inflation. These effects increase the financial system vulnerability in recessions, and could be stronger in emerging markets under dollarization. As the current prudential regulation could increase banking system vulnerability in a recession, by using a Dynamic Stochastic General Equilibrium Model (DSGE), with banks and prudential regulation, I show that a countercyclical capital requirement could help to reduce these effects and to keep the strength and solvency of the financial system. Therefore it is ne...
We identify and measure the impact of inefficient LJC systems on Loss Given Default (LGD). Becaus... more We identify and measure the impact of inefficient LJC systems on Loss Given Default (LGD). Because LGD is a key risk component of the new framework to measure capital adequacy, this document explains how an inefficient judiciary system, a poor body of property and legal rights or a slow and costly collateral collection procedure may add an implicit charge in capital. In this sense, Basel II should play an additional role in promoting institutional reforms in developing countries to guarantee financial stability and soundness. By using data related to legal restrictions in doing businesses for a large set of countries, we find strong evidence that improving LJC systems reduces the LGD making the impact of implementation Basel II less challenging.
The paper develops a methodology for the creation of an index of banking system's vulnerability t... more The paper develops a methodology for the creation of an index of banking system's vulnerability that can be used, as an early warning system, to assess the soundness of banking systems in developing countries. This index is based on the weighted-by-assets probability of banks classified as unsound by the supervisory agency. Applying the index for the case of Peru, it is shown that the index provides more relevant information, in advance, about the fragility of the banking system than failure models. We found that the determinants of banks' weaknesses are individual risks taken by financial institutions and external economic risks. The latter also help to determine the period of time before a bank is declared unsound. We also conclude that the banking system fragility's index in the case of Peru has a feedback causality with the economic activity, and they are negatively correlated. This result makes a case for banking regulation.
A Practical Example of the Nonperforming Loans Projection Approach to Stress Testing
approach to stress testing was deemed appropriate. Th e approach presented in this chapter is rel... more approach to stress testing was deemed appropriate. Th e approach presented in this chapter is relatively straightforward compared with modeling techniques used to assess more Th is chapter describes the features of a stress testing model that was developed for a small open economy with a relatively large banking sector. As most banks in the sector follow a traditional intermediation model focused on lending and bank CHAPTER 30
This paper analyzes, in an emerging market context, the effects of financial frictions and bank p... more This paper analyzes, in an emerging market context, the effects of financial frictions and bank prudential regulation on the business cycle. It also proposes a prudential rule that smoothes the external finance premium, and at the same time, improves the effectiveness of the monetary policy. I hypothesize that the macroeconomic effects of bank capital requirements are procyclical and lead to the amplification of monetary shocks, therefore reducing their effectiveness for fighting inflation. These effects increase the financial system vulnerability in recessions, and could be stronger in emerging markets under dollarization. As the current prudential regulation could increase banking system vulnerability in a recession, by using a Dynamic Stochastic General Equilibrium Model (DSGE), with banks and prudential regulation, I show that a countercyclical capital requirement could help to reduce these effects and to keep the strength and solvency of the financial system. Therefore it is ne...