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Prudential filters, portfolio composition at fair value and capital ratios in European banks

Isabel Argimon (), Michel Dietsch and Angel Estrada ()

Journal of Financial Stability, 2018, vol. 39, issue C, 187-208

Abstract: European banks hold 10% of their total assets in portfolios that give rise to unrealised gains and losses which, under Basel III, may no longer be removed from banks’ regulatory capital. Using a sample of European banks, and taking advantage of the different regulatory treatment afforded, under Basel II, to such gains and losses across jurisdictions and instruments and over time, we find evidence that: a) the inclusion of unrealised gains and losses in regulatory capital ratios increases their volatility; b) the total or partial inclusion in regulatory capital of unrealised gains and losses on fixed-income securities reduces the volume of debt at fair value, thus potentially affecting the demand for liquid long-term securities (most of which are currently government bonds); and c) the higher the proportion of gains on debt instruments allowed in regulatory capital, the higher the regulatory Tier 1 capital ratio, thus affecting banks’ capital buffer strategy.

Keywords: Prudential regulation; Regulatory capital; Fair value accounting; Prudential filters (search for similar items in EconPapers)
JEL-codes: G21 G28 M41 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1016/j.jfs.2017.03.004

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