Is Current Capital Regulation Based on Conservative Risk Assessment?

Thomas Breuer (), Martin Jandacka (), Klaus Rheinberger () and Martin Summer
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Thomas Breuer: Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.
Martin Jandacka: Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.

Financial Stability Report, 2008, issue 15, 112-118

Abstract: We criticize the popular view that separately calculating regulatory capital for market and credit risk yields a conservative aggregate risk assessment. We show that this view depends on a flawed intuition about diversification effects that arise between subportfolios. If a bank’s portfolio cannot be neatly divided into two subportfolios along the lines of market and credit risk, simply adding up the respective results may cause the true portfolio risk to be underestimated. Using the example of foreign currency loan portfolios, we show that this underestimation can be quantitatively significant.

Keywords: Integrated analysis of market and credit risk; risk management; foreign currency loans; banking regulation. (search for similar items in EconPapers)
JEL-codes: C15 G20 G28 G32 (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (4)

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