Capital Adequacy, Pro-cyclicality and Systemic Risk

Raphael Douady ()

A chapter in Future Perspectives in Risk Models and Finance, 2015, pp 137-148 from Springer

Abstract: Abstract VaR-based capital adequacy as specified by Basel II accords is subject to procyclical effects, potentially aggravating systemic risk, when it is supposed to mitigate it, as observed during 2008 crisis. Supposed improvements in Basel III, not only don’t resolve the problem, but introduce new sources of systemic risk. The method proposed here for computing the regulatory capital of financial institutions avoids the pitfalls of the Value-at-Risk. The computation is based on a generalized stress testing method, with the following principles: (i) market scenarios are defined by the regulator; (ii) institutions compute the impact of scenarios defined by the regulator and report them; (iii) the regulator not only counts the number of violations of the risk reporting but also their size; (iv) the regulatory capital is a multiple of the worst stress test, where the multiplier depends on the size and the frequency of the violations. By letting the institutions estimate their sensitivities to extreme market shifts, the regulator not only avoids a costly burden, but also keeps institutions responsible for their reporting. On the other hand, by keeping control on the list of stress tests involved in the computation of the capital, the regulator offers itself a very strong lever to prevent speculative bubbles, by making them costly in terms of capital requirements.

Keywords: Risk Measure; Systemic Risk; Regulatory Capital; Market Risk; Asset Class (search for similar items in EconPapers)
Date: 2015
References: Add references at CitEc
Citations:

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

Related works:
Working Paper: Capital Adequacy, Pro-cyclicality and Systemic Risk (2015)
Working Paper: Capital Adequacy, Pro-cyclicality and Systemic Risk (2015)
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:spr:isochp:978-3-319-07524-2_5

Ordering information: This item can be ordered from
http://www.springer.com/9783319075242

DOI: 10.1007/978-3-319-07524-2_5

Access Statistics for this chapter

More chapters in International Series in Operations Research & Management Science from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().