Industry Practices in Credit Risk Modeling and Internal Capital Allocations: Implications for a Models-Based Regulatory Capital Standard: Summary of Presentation (original) (raw)

The ascent and descent of banks’ risk-based capital regulation

Journal of Banking Regulation

The emergence of risk-based capital regulation that is allowing banks to use their internal risk models for regulatory purposes was among the main regulatory developments prior to the financial crisis. During the crisis, it became evident these models underestimated the level of risk. The post-crisis regulatory approach brought a reversal of policy by significantly reducing the scope of risk-based capital regulation and making regulations less risk-sensitive. At first glance, this appears to be a step back toward an antiquated, less sophisticated regulatory regime. This article analyses these two regulatory policy transformations: from less risk-sensitive to risk-based before the crisis and from risk-based to less risk-sensitive subsequently. Its main conclusion is that a mixed regulatory system is superior to either purely non-risk-sensitive or purely risk-based regulation, because a mixed system can help mitigate the negative incentives of both non-risk-sensitive and risk-based re...

The New Approach for Risk Regulation in Banks

Chinese Business Review

The purpose of this report is to present the necessity of proceeding to new reforms in bank regulation and to increase the stability and risk sensitivity of the capital base under applying the Standardised Credit Risk Assessment Approach (SCRA) in banks. The dynamics in the bank regulation and supervision of credit risk assessment approaches are explored. In the paper, a thorough theoretical-methodological and historical-logical analysis was made of the evolution of the development and chronology of the global regulatory frameworks for banks-Basel 1, Basel 2, and Basel 3. The contemporary projections and challenges for the banks' management under the new regulatory and institutional changes are presented. The SCRA is a positive asset in bank capital regulation in contemporary banking. The revisions to the regulatory framework by Basel 3 are a long continuous process influenced by numerous economic, social, and political factors. The preparation of the Bulgarian banking system for a new reform of financial regulation is analyzed. The need for adoption of a new risk-based approach for capital assessment and the importance of transparency in bank financial reporting is proved.

Regulating Market Risks in Banks: A Comparison of Alternate Regulatory Regimes

2001

Regulators have traditionally used simple models to measure the capital adequacy of banks. The growing internationalization and universalisation of banking operations has meant that the same is no longer possible as banks face increasing, and increasingly opaque, market risk. The significance of market risk has also been acknowledged in the New Capital Accord enunciated by the Basel Committee in 1999. The focus of the paper is on market risk-any market related factor that affects the value of a position in the financial instrument or a portfolio of instruments. As it stands at present, the three commonly used approaches to regulating market risks in banks include the building bloc approach, internal model approach and pre-commitment approach. The paper evaluates the pros and cons of the various approaches and concludes with a discussion of the applicability of these models in the Indian context.

A Principles-Based Approach to Regulatory Capital for Securitisations

This paper develops a principles-based approach to calculating regulatory capital for securitisations. The approach is simpler and more transparent than the Basel Committee’s proposed Modified Supervisory Formula Approach (MSFA) and avoids the latter’s numerous opaque approximations. Importantly, our proposed approach is directly consistent with the Basel II Internal Ratings-Based Approach (IRBA) capital formulae for on-balance sheet loans. It is therefore “capital neutral” (at least, before model risk charges or other add-ons) in that a bank holding all the tranches of a securitisation will face the same capital charge as if it retains the securitisation pool assets as directly held exposures. Our suggested approach is therefore, less likely to encourage capital arbitrage.

On the Role of Regulatory Banking Capital

Financial Markets, Institutions & Instruments, 2008

In this paper the authors study the role of regulatory banking capital and analyze the incentive effects of the Basel II Accord. They argue that Basel II may become a source of systemic risk due to endogenous risk and the risk sensitivity of the capital requirements. In this context they note that financial instability may enter via the asset side of the banks' balance sheets when banks are forced to sell assets in order to maintain the capital buffer prescribed by Basel II.

Critical Analysis of the New Basel Minimum Capital Requirements for Market Risk

In its October 2013's consultative paper for a revised market risk framework (FRTB), and subsequent versions published thereafter, the Basel Committee suggests new ways of dealing with market risk in banks' trading and banking books. The Basel Committee estimates that the new rules will result in an approximate median capital increase of 22% and a weighted average capital increase of 40% [1], compared with the current framework. Key changes can be found in the internal model approach, in the standard rules and in the scope/approval process. Among the significant changes that are being introduced by the FRTB is a stricter separation of the trading book and banking book. Regardless of whether they use standardised or internal models, banks will need to review their portfolios to determine if existing classifications of instruments and desks as trading book or banking book are still applicable or whether a revision of desk structure is needed. In this article, we analyse the theoretical foundations of the internal model approach (IMA), which are the stressed expected shortfall, liquidity adjustments, default & migration risk and non-modellable risk factors. We thoroughly investigate the criticisms for Internal Risk Model (IMA) and the introduction of a standardised floor, the sensitivity based approach (SBA) with Delta, Vega and Curvature, shock scenarios and the aggregation with asymmetric correlation and reflection of basis/default risk.

Evaluating Risk-Based Capital Regulation

SSRN Electronic Journal, 2013

Risk-based capital (RBC) ratios are an important component of US banking regulation, yet empirical evidence on the effectiveness of RBC regulation has been mixed. Avery and Berger (1991) find that the RBC ratio improves upon the standard capital ratio of equity over assets. This paper identifies some potential flaws in the Avery and Berger (1991) methodology and proposes a more direct method of comparing capital and RBC. We evaluate the capital and RBC ratios of US commercial banks from 2001 through 2011 and find the standard capital ratio to be a significantly better predictor of bank performance than the RBC ratio. The results have significant implications for US banking regulation.