How Do Investors Prefer for Banks to Transition to Basel Internal Models: Mandatorily or Voluntarily?

Henry Penikas, Anastasia Skarednova and Mikhail Surkov
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Anastasia Skarednova: ��Treasury, Research & Modelling, Alfa-Bank, 27 Kalanchevskaya Street, Moscow 107078, Russian Federation
Mikhail Surkov: ��Banking Regulation and Analytics Department, Bank of Russia, 12 Neglinnaya Street, Moscow 107016, Russian Federation

Quarterly Journal of Finance (QJF), 2023, vol. 13, issue 02, 1-24

Abstract: The recently finalised Basel Framework continues to allow banks to use internal data and models to define risk estimates and use them to compute their capital adequacy ratios. Globally, there are more than two thousand banks running Basel internal models. However, there are countries that have no such banks. They face the dilemma of which of the transition paths to adopt: the voluntary path, as in the EU, or the mandatory path, as in the US. Our objective is to take an investor’s perspective and benchmark the two modes. Thus, we wish to determine whether there is a premium for either of them or whether they are, perhaps, equivalent. The novelty of our research is in its robust estimate that investors prefer a mandatory transition to a voluntary one if we consider the period of the 2007–2009 crisis. However, the use of the common post-crisis sample yields the opposite conclusion. A voluntary transition is preferred, though it implies a rise in stock volatility, and thus, the overall risk-return relationship is preserved. This is mostly driven by the tighter used when adopting internal models in the US compared to the EU. European banks have had more room to expand their business after the IRB transition, while for US banks, the transition involved a reduction in business, all else being equal. Our findings are of value primarily to emerging economies such as Argentina or Indonesia.

Keywords: Basel II; Basel III; BCBS; CAR; difference-in-differences; D-SIB; G-SIB; IRB; risk weight (search for similar items in EconPapers)
JEL-codes: C21 G12 G17 G18 G21 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1142/S2010139223400025

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