Evaluating the Basle Guidelines for Backtesting Banks' Internal Risk Management Models

Andre Lucas

Journal of Money, Credit and Banking, 2001, vol. 33, issue 3, 826-46

Abstract: The 1996 Amendment to the Baste capital accord to incorporate market risks constitutes a breakthrough in the determination of capital requirements. Rather than dictating these requirements through a uniform supervisory approach, banks are allowed to use their own, internal models for computing the capital required. In order to mitigate moral hazard problems and stimulate banks to use adequate internal models, the models must be subjected to a backtesting procedure. If a model produces too many incorrect predictions, increased capital requirements result. This paper provides an evaluation of the current internal models approach in conjunction with the proposed backtesting procedure. In particular, using a stylized representation of the present supervisory framework, we investigate whether banks are provided with the right incentives to come up with the correct internal model. We find that under the current regulatory framework banks are prone to under-reporting their true market risk. A much stricter penalty scheme is required in order to align banks' incentives with those of the supervisor. We check the sensitivity of our results to changes in the length of the planning horizon, portfolio risk, time preferences, risk attitudes, and the distribution of financial returns.

Date: 2001
References: Add references at CitEc
Citations: View citations in EconPapers (21)

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:mcb:jmoncb:v:33:y:2001:i:3:p:826-46

Access Statistics for this article

Journal of Money, Credit and Banking is currently edited by Robert deYoung, Paul Evans, Pok-Sang Lam and Kenneth D. West

More articles in Journal of Money, Credit and Banking from Blackwell Publishing
Bibliographic data for series maintained by Wiley-Blackwell Digital Licensing () and Christopher F. Baum ().