Regulatory Capital and Incentives for Risk Model Choice under Basel 3*

Procyclical Leverage and Value-at-Risk

Fred Liu and Lars Stentoft

Journal of Financial Econometrics, 2021, vol. 19, issue 1, 53-96

Abstract: In response to the Subprime mortgage crisis, the Basel Committee on Banking Supervision (BCBS) has spent the previous decade overhauling the regulatory framework that governs how banks calculate minimum capital requirements. In 2019, the BCBS finalized the Basel 3 regulatory regime, which changes the regulatory measure of market risk and adds new complex calculations based on liquidity and risk factors. This article is motivated by these changes and seeks to answer the question of how regulation affects banks’ choice of risk-management models, whether it incentivizes them to use correctly specified models, and if it results in more stable capital requirements. Our results show that, although the models that minimize regulatory capital for a representative bank portfolio also result in the most stable requirements, these models are generally rejected as being correctly specified and tend to produce inferior forecasts of the regulatory risk measures.

Keywords: Basel 3; expected shortfall backtesting; regulatory capital requirements (search for similar items in EconPapers)
JEL-codes: C14 C22 C53 G32 (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (3)

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