Abstract / Description of output
With the majority of large UK and many US banks collapsing or being forced to raise capital over the 2007-9 period, blaming bankers may be satisfying but is patently insufficient; Basel II and Federal oversight frameworks also deserve criticism. We propose that the current methodological void at the heart of Basel II, Pillar 2 is filled with the recommendation that banks develop fully-integrated models for economic capital that relate asset values to fundamental drivers of risk in the economy to capture systematic effects and inter-asset dependencies in a way that crude correlation assumptions do not. We implement a fully-integrated risk analysis based on the balance sheet of a composite European bank using an economic-scenario generation model calibrated to conditions at the end of 2007. Our results suggest that the more modular, correlation-based approaches to economic capital that currently dominate practice could have led to an undercapitalisation of banks, a result that is clearly of interest given subsequent events. The introduction of integrated economic-scenario-based models in future can improve capital adequacy, enhance Pillar 2's application and rejuvenate the relevance of the Basel regulatory framework. (C) 2010 Elsevier B.V. All rights reserved.
Original language | English |
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Pages (from-to) | 2838-2850 |
Number of pages | 13 |
Journal | Journal of Banking and Finance |
Volume | 34 |
Issue number | 12 |
DOIs | |
Publication status | Published - Dec 2010 |
Keywords / Materials (for Non-textual outputs)
- risk management
- economic capital
- enterprise risk management
- Basel II
- Solvency II
- stochastic models
- stress testing