Capital Adequacy Tests and Limited Liability of Financial Institutions

Pablo Koch-Medina, Santiago Moreno-Bromberg and Cosimo Munari
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Pablo Koch-Medina: University of Zurich - Department of Banking and Finance; Swiss Finance Institute
Santiago Moreno-Bromberg: University of Zurich - Department of Banking and Finance
Cosimo Munari: University of Zurich - Department of Banking and Finance; Swiss Finance Institute

No 14-03, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: The theory of acceptance sets and their associated risk measures plays a key role in the design of capital adequacy tests. The objective of this paper is to investigate, in the context of bounded financial positions, the class of surplus-invariant acceptance sets. These are characterized by the fact that acceptability does not depend on the positive part, or surplus, of a capital position. We argue that surplus invariance is a reasonable requirement from a regulatory perspective, because it focuses on the interests of liability holders of a financial institution. We provide a dual characterization of surplus-invariant, convex acceptance sets, and show that the combination of surplus invariance and coherence leads to a narrow range of capital adequacy tests, essentially limited to scenario-based tests. Finally, we emphasize the advantages of dealing with surplus-invariant acceptance sets as the primary object rather than directly with risk measures, such as loss-based and excess-invariant risk measures, which have been recently studied by Cont, Deguest & He and by Staum, respectively.

Keywords: surplus invariance; limited liability; capital adequacy; risk measures; loss-based risk measures; shortfall risk measures; excess invariance (search for similar items in EconPapers)
JEL-codes: C60 G11 G22 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2014-01
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1403

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