Risk-based capital adequacy standards for a sample of 43 major banks

Abstract

The paper extends the option-theoretic framework for the estimation of risk-adjusted deposit premiums to the calculation of risk-based capital adequacy standards. Based on market data for equity and the book value of debt, the model solves for the market value of the capital infusion required to lower the implied deposit premium to acceptable levels of risk. This capital infusion can then be translated into market-value capital adequacy standards and book-value capital-asset ratios, the determination of which is within the current statutory discretion of regulatory agencies. The model is empirically applied to a sample of 43 major U.S. banks.