Basel Capital Accord Research Articles

Exploring Industry-Distress Effects on Loan Recovery: A Double Machine Learning Approach for Quantiles

In this study, we explore the effect of industry distress on recovery rates by using the unconditional quantile regression (UQR). The UQR provides better interpretative and thus policy-relevant information on the predictive effect of the target variable than the conditional quantile regression. To deal with a broad set of macroeconomic and industry variables, we use the lasso-based double selection to estimate the predictive effects of industry distress and select relevant variables. Our sample consists of 5334 debt and loan instruments in Moody’s Default and Recovery Database from 1990 to 2017. The results show that industry distress decreases recovery rates from 15.80% to 2.94% for the 15th to 55th percentile range and slightly increases the recovery rates in the lower and the upper tails. The UQR provide quantitative measurements to the loss given default during a downturn that the Basel Capital Accord requires.

The nexus between interest rate and bank profitability: Does bank prudential capital matter?

The credit expansion policy and banking regulations have attracted widespread attention of bank regulators and policymakers over the last few years. This research aims to examine how the interest rate, prudential capital, and their interaction impact banking profitability in emerging economies like Egypt. The final sample of banks registered by the Central Bank of Egypt comprises 22 banks during the period of 2011–2020. The cross-sectional time-series Generalized Least Squares (GLS) regression approach is used to estimate the panel data. The findings confirm that low-interest rates indeed harm banks’ profitability. In addition, higher prudential capital enhances the profitability of banks. Importantly, the impact of low-interest rates on bank profitability can be diminished only when banks are maintaining higher prudential capital. Based on the findings, it is recommended that bank managers and policymakers in Egypt as well as in similar emerging economies shall promote the application of the Basel Capital Accord to increasingly strengthen the profitability of banks, which in turn reinforces the performance of the banking sector, especially during low-interest rate times. The findings also reveal that bank-specific characteristics such as large bank size, increased efficiency, and less concentrated market enhance banks’ profitability. Overall, the findings of this research are highly relevant since improved profitability is one of the main objectives of bank supervisors and regulators. AcknowledgmentsThe authors are grateful to Mr. Ali Shaker and Amira Ragab for their valuable support.

Industry Distress and Default Recovery Rates: The Unconditional Quantile Regression Approach

In this study, we estimate the effect of industry distress on recovery rates by using the unconditional quantile regression (UQR) proposed in Firpo, Fortin, and Lemieux (2009). The UQR provides better interpretative and thus policy-relevant information on the marginal effect of the covariates than the conditional quantile regression (CQR, Koenker and Bassett, 1978). To deal with a broad set of macroeconomic and industry variables, we use the LASSO-based double selection to identify the effects of industry distress and select variables.Our sample consists of 5,334 debt and loan instruments in Moody's Default and Recovery Database from 1990 to 2017. The results show that industry distress decreases recovery rates from 15.80% to 2.94% for the 15th to 55th percentile range and slightly increases the recovery rates in the lower and the upper tails. In contrast to the CQR, the UQR provide quantitative measurements to the loss given default during a downturn that the Basel Capital Accord requires.

The Financial Stability Board and Switzerland’s WiR-Credit Mechanism

:The incentives banks face, such as the Basel Capital Accords, motivate them to favor lending with collateralized assets, rather than lending to Small-Medium Enterprises (SMEs), with associated profound economic consequences for society. Since the 1970s there has not been any direct oversight of whether or not credit contributes to GDP. We need a macroeconomic policy tool that can discriminate among different categories of credit extended to curb speculation in existing assets (non-GDP) and promote new business investment (GDP).Government money creation and private credit growth are often presumed the only two ways to enhance nominal demand, yet the Swiss Economic Circle (Wirtschaftsring-Genossenschaft or WIR) is a Swiss Bank whose creation of purchasing power for SMEs has counter-cyclically stabilized the Swiss economy for over 80 years. The Financial Stability Board (FSB) should create localized credit-creation architectures utilizing a Swiss-WIR type currency to funnel credit that reflects systemic and macroeconomic risks that individually will never be rational for banks left to themselves.

Bank Regulatory Reforms and Institutional Equity Holdings

This paper examines the effects of changes in bank regulatory environment on the risk, return, and liquidity characteristics of equity portfolios of U.S. bank holding companies between 1997 and 2016. Using a comprehensive sample of bank and hedge fund holdings data we examine the impact of the repeal of the Glass-Steagall Act, the introduction of the second and third Basel Capital Accords, and the implementation of the Dodd-Frank legislation on institutional portfolios. We document a significant increase in both the idiosyncratic volatility and illiquidity of banks' portfolios during the period of financial deregulation initiated by the formal removal of restrictions prohibiting banks from engaging in securities trading. In contrast, subsequent reforms of the bank capital requirements system and the prohibition of banks from proprietary trading activities lead to reductions in those metrics. Our results suggest that banks' restricted ability to engage in market-making can be offset by the activities of hedge funds, although the consequences of this substitution for long-term market stability remain unclear.

Operational risk quantified with spectral risk measures: a refined closed-form approximation

The quantification of operational risk has become an important issue as a result of the new capital charges required by the Basel Capital Accord (Basel II) to cover the potential losses of this type of risk. In this paper, we investigate second-order approximation of operational risk quantified with spectral risk measures (OpSRMs) within the theory of second-order regular variation (2RV) and second-order subexponentiality. The result shows that asymptotically two cases (the fast convergence case and the slow convergence) arise depending on the range of the second-order parameter. We also show that the second-order approximation under 2RV is asymptotically equivalent to the slow convergence case. A number of Monte Carlo simulations for a range of empirically relevant frequency and severity distributions are employed to illustrate the performance of our second-order results. The simulation results indicate that our second-order approximations tend to reduce the estimation errors to a great degree, especially for the fast convergence case, and are able to capture the sub-extremal behavior of OpSRMs better than the first-order approximation. Our asymptotic results have implications for the regulation of financial institutions, and may provide further insights into the measurement and management of operational risk.

Central bank disclosure as a macroprudential tool for financial stability

The Basel Capital Accord (pillar 3) states that disclosure of information (transparency) is essential to financial stability. This study analyzes, through inflation reports, the disclosure of information from the Central Bank of Brazil concerning the credit market. We consider credit risk and capital buffers as measures of financial stability in this analysis. Furthermore, in order to measure the perception of the monetary authority on the credit market, we built two indices based on the central bank’s communication on credit development. We performed a panel data analysis based on a sample of 125 banks for the period from June 1999 to September 2014 (7000 observations). The findings suggest that central bank communication regarding expectations concerning the credit market contributes to financial stability. Therefore, this kind of communication of central banks (about credit development) may constitute an important macroprudential tool to improve financial stability.

How the financial crisis has changed the research agenda on banking regulation

The effects of the financial crisis, which began in 2007, were many and various. This paper examines those effects in the banking regulation and supervision research agendas. The crisis, as the most important economic and social event of the beginning of this century, has triggered debates in multiple spaces and across frameworks, in politics, the media, social networks, and elsewhere. As the crisis was focused in the financial sector, it is natural for the published academic investigation of the regulation of this sector to have suffered changes. With this paper, the author tries to understand the impact of the financial crisis started in 2007 in the research published about banking regulation. This study, using a 323-article sample, determined that there was a change in the volume of published investigations, evident after 2011. This indicates a time lag between the onset of the crisis and the growth of interest in its inherent themes. This study also testifies to a change in interest focuses, with new themes emerging, such as politics, Basel III, systemic risk, and regulatory capture. Further, the keywords with value at risk, Basel II, Basel Capital Accords, and market discipline lost some ground in literature.

Bridging the gap: the regulatory dimension of secured transactions law reforms

The lack of coordination between secured transactions law and capital requirements generates tensions in the legal framework governing extension of credit secured by movable assets. Contrary to common assumptions, secured transactions law reforms do not necessarily improve access to credit if regulatory considerations are not properly addressed. With primary reference to the Basel Capital Accords and the UNCITRAL Model Law, this article isolates the regulatory requisites for security rights in movable assets to reduce capital requirements. Moving from this analysis, this article then offers a regulatory strategy to sustain secured transactions law reforms at the national level.

An application of extreme value theory in estimating liquidity risk

The last global financial crisis (2007–2008) has highlighted the weaknesses of value at risk (VaR) as a measure of market risk, as this metric by itself does not take liquidity risk into account. To address this problem, the academic literature has proposed incorporating liquidity risk into estimations of market risk by adding the VaR of the spread to the risk price. The parametric model is the standard approach used to estimate liquidity risk. As this approach does not generate reliable VaR estimates, we propose estimating liquidity risk using more sophisticated models based on extreme value theory (EVT). We find that the approach based on conditional extreme value theory outperforms the standard approach in terms of accurate VaR estimates and the market risk capital requirements of the Basel Capital Accord.

An optimal investment and risk control policy for a bank under exponential utility

ABSTRACTMotivated by the Basel Capital Accord Requirement (CAR), we analyze a risk control portfolio selection problem under exponential utility when a banker faces both Brownian and jump risks. The banker's risk process and the dynamics of the risky asset process are modeled as jump-diffusion processes. Assuming that the constraint set of all trading strategies is in a closed set, we study the terminal utility optimization problem via the backward stochastic differential equation (BSDE) under risk regulation paradigm. We construct the BSDE by means of the martingale optimality principle, giving conditions for the corresponding generator to be well defined in order to derive the bounds on the candidate optimal strategy. We then construct an internal model for the bank under Basel III CAR, which is formulated from the total risk-weighted assets (TRWA's) and bank capital. The results obtained from this model can be adopted within the banking sector when setting up asset investment strategies and advanced risk management models, as advocated by the Basel III Accord.

Palestine Banks Sector Ability to Apply Credit Risk Management According to Basel III

In this paper, we integrated a novel framework to develop credit risk management systems for Palestinian banks based on international standards (Basel Capital Accord). First, we evaluate the credit risk management systems and strategies that the operating bank in Palestinian banking system mandate. Second, we used the analytical description methodology to describe the new Basel accord for effective banking supervision. Our study showed that despite the efficiency of personnel in the credit technical staff, it is still difficult for Palestinian banks to measure credit risks according to Basel III approaches.

Market Discipline Working for and against Financial Stability: The Two Faces of Equity Capital in U.S. Commercial Banking

The second Basel Capital Accord points to market discipline as a tool to reinforce capital standards and supervision in promoting bank safety and soundness. The Bank for International Settlements contends that market discipline imposes strong incentives on banks to operate in a safe and efficient manner – in particular, to maintain an adequate capital base to absorb potential losses from their risk exposures. Using 2007 and 2013 data on top-tier, publicly traded U.S. bank holding companies, we find that market discipline rewards risk-taking at some of the largest U.S. financial institutions. In particular, we find evidence of two faces of equity investment – dichotomous capital strategies for maximizing value. At banks with higher-valued investment opportunities, a marginal increase in their equity capital ratio is associated with better financial performance, while at banks with lower-valued investment opportunities, a marginal decrease in their equity capital ratio is associated with better financial performance. Because the largest U.S. financial institutions tend to have lower-valued investment opportunities, our results suggest that they may have a market-based incentive to reduce their capital ratio. To the extent that market discipline rewards reducing the capital ratio among the largest banks, it would tend to undermine financial stability. Our results support the need for regulatory capital requirements.

Basel Capital Adequacy Ratio Standard in The Light of Islamic Law Perspective

Bank is one of the most important pillars of economy activities. However, banking sector has a real potential crisis threat. Alongside with the steady current global banking development, financial crises that have happened clearly affected global economy. Based on that situation, BIS (Bank for International Settlement) – an international financial standard setting organization, realizes the urgency to establishan international financial standard and supervision to anticipate future potential financial crises. This research aims to identify how Capital Adequacy Ratio Standard in Basel Capital Accord (II) based on Islamic law perspective. The research is conducted by analyzing Basel Capital Accord published by BIS. The research uses library research method to find out the aimed result. The focus is on the 1st pillar of Basel II publication that is Minimum Capital Requirements (CAR) policy. CAR, as an Islamic economics policy, will be analyzed using falāḥ approach. Falāḥ is an Islamic economics objective that consists of happiness, success, accomplishment or good luck concept. The earthly dimension of falāḥ has some parameters that can be used to analyze Islamic economics policy. Additionally, the Islamic fiqh maxim takes part in analyzing the policy. The maṣlaḥat concept in fiqh maxim approach shares aim with falāḥ concept in the sense that all of sharia law aims for success, happiness, eternal survival etc. The maṣlaḥat can be accomplished by extinguishing mafsadat or seizing maṣlaḥat. The maṣlaḥat aspect is essential to determine the compatibility Basel Capital Accord with jurisprudential maxim i.e harm must be dispelled (al-dharāru yuzāl). The conclusion results are, 1) Basel Capital Accord focuses on macro-prudential aspect in order to anticipate potential financial crises, 2) beneficial/interest (maṣlaḥat) aspects of the hereafter, cooperation principle, justice, fairness and the prohibition of exploitation are not the core value of Basel Capital Accord frame work, thus 3) the achievement of maslahat as intended by sharia i.e. jurisprudential maxim are not convincing. Therefore, 4) Basel Capital Accord as a regulation basis is not in line with jurisprudential maxim i.e harm must be dispelled (al-dharāru yuzāl).

A note on the adequacy of the EU scheme for bank recovery, resolution and deposit insurance in Spain

This article analyzes whether the funds set by the recent EU directives on bank resolution and deposit insurance to create a safer and sounder financial sector (that is, 1 and 0.8 per cent of covered deposits, respectively) are adequate to cover unexpected losses for the Spanish banking system. By applying a framework based on the foundation internal ratings-based approach established in Basel Capital Accords, we find that the fixed target levels proposed by the EU bank rules would not ensure the highest credit quality for a bank resolution and deposit insurance Fund in Spain. Nevertheless, these resources would be sufficient to ensure a good solvency level for the Fund, equivalent to an AA S&P rating in 2013.

The Effect of Regulatory and Risk Management Advancement on Non-Performing Loans in European Banking, 2000–2011

We study whether the implementation of advanced risk management techniques in compliance with the internal ratings-based (IRB) approaches in the Basel Capital Accord reduced non-performing loans (NPLs) and, hence, had a significant impact in controlling credit risk in emerging and advanced European banks during 2000–2011. Our analysis reveals that there exists wide variation in terms of adoption of such advanced techniques across European banks. Emerging Europe, which suffered the most from the surge in NPLs in the post-crisis period, lags significantly behind the Eurozone economies in terms of the intensity of IRB adoption rates. We employ dynamic generalized method of moments (GMM) estimation methods in our panel regressions to investigate the effect of such regimes on the level of NPLs on a country level. Our findings confirm that the intensity of IRB usage within a banking system leads to a statistically significant decrease in the aggregate amount of NPLs in the post-crisis period, after controlling for macroeconomic and bank-specific characteristics of individual economies. This result is consistent with the view that the efficiency of credit risk management may turn out to be a critical factor in avoiding widespread banking distress and for improving the profitability and solvency of banking systems as a whole.

Mean-univariate GARCH VaR portfolio optimization: Actual portfolio approach

In accordance with Basel Capital Accords, the Capital Requirements (CR) for market risk exposure of banks is a nonlinear function of Value-at-Risk (VaR). Importantly, the CR is calculated based on a bank’s actual portfolio, i.e. the portfolio represented by its current holdings. To tackle mean-VaR portfolio optimization within the actual portfolio framework (APF), we propose a novel mean-VaR optimization method where VaR is estimated using a univariate Generalized AutoRegressive Conditional Heteroscedasticity (GARCH) volatility model. The optimization was performed by employing a Nondominated Sorting Genetic Algorithm (NSGA-II). On a sample of 40 large US stocks, our procedure provided superior mean-VaR trade-offs compared to those obtained from applying more customary mean-multivariate GARCH and historical VaR models. The results hold true in both low and high volatility samples.

Estimation of default probability for corporate entities in Republic of Serbia

In this paper a quantitative PD model development has been excercised according to the Basel Capital Accord standards. The modeling dataset is based on the financial statements information from the Republic of Serbia. The goal of the paper is to develop a credit scoring model capable of producing PD estimate with high predictive power on the sample of corporate entities. The modeling is based on 5 years of end-of-year financial statements data of available Serbian corporate entities. Weight of evidence (WOE) approach has been applied to quantitatively transform and prepare financial ratios. Correlation analysis has been utilized to reduce long list of variables and to remove highly interdependent variables from training and validation datasets. According to the best banking practice and academic literature, the final model is provided by using adjusted stepwise Logistic regression. The finally proposed model and its financial ratio constituents have been discussed and benchmarked against examples from relevant academic literature.

Kalkulacja wymogu kapitałowego z tytułu ryzyka operacyjnego w zgodzie z dyrektywą w sprawie wymogów kapitałowych - CRD IV

Operational risk is defined as the possibility of losses resulting from the failure, deficiency or inadequacy of internal processes, people and systems, or from external events. Operational risk measurement methods differ from techniques applied to other types of risk. The importance of operational risk has increased substantially in recent years due to huge losses suffered by renowned financial institutions. These led to the publication of the European Union Capital Requirements Directive (CRD), introduced by the so-called Basel II-based definition of banks' capital requirements. The main objective of the paper is to analyse the operational risk measurement methods proposed in the New Basel Capital Accord: the Basic Indicator Approach, the Standardised Approach, and Advanced Measurement Approaches (AMA). The author analysed, in successive stages of the paper, the definition and characteristics of operational risk and methods of calculating capital requirements.

Global Financial Standard Setting, the G10 Committees, and International Economic Law

he global financial and credit crisis of 2007!2009 has highlighted the important role of the G10 committees in setting international standards for the regulation of bank capital adequacy, payment systems, and related issues pertaining to global financial stability. The main three G10 committeesconsisting of the Basel Committee on Banking Supervision (#Basel Committee$ or #BCBS$), the Committee on Payment and Settlement Systems (#CPSS$), and the Committee on the Global Financial Systemare the most influential international financial standardsetting bodies and exercise either direct or indirect influence over the development of banking and payment system law and regulation for all developed countries and most developing countries. Specifically, the Basel Committee has produced a number of important international agreements that regulate the amount of capital that banks must set aside against their risk-based assets, and the allocation of jurisdictional responsibility for bank regulators in overseeing the international operations of banks. Its activities have usually been kept away from the fanfare of high politics, but its recent efforts to amend the 1988 Basel Capital Accord by adopting the Basel II Capital Agreement (#Basel II$) and to extend its application to all countries where international banks operate have attracted significant critical comment and brought its work under close scrutiny by leading policymakers and regulators. The CPSS has created important agreements setting forth principles and recommendations for the regulation of bank payment systems and for the regulation of clearing and settlement of securities trading, and recommendations regarding counterparties. The Committee on Global Financial Systems, though it has not yet adopted regulatory principles or recommendations, has produced a number of influential reports that have influenced the debate on