Table of Contents

Basel III B: Basel III Overview

Christian McNamara, Yale University - Yale Program on Financial Stability
Michael Wedow, European Central Bank (ECB) - Directorate Financial Stability and Supervision, Deutsche Bundesbank
Andrew Metrick, Yale School of Management, National Bureau of Economic Research (NBER)

Dynamic Stress Test Diffusion Model Considering the Credit Score Performance

Ziad Fares, Chappuis Halder & Cie. - New York Office
Benoit Genest, Chappuis Halder & Cie. - London Office
Arnault Gombert, Chappuis Halder & Cie. - Global Research & Analytics Department

A Margin Call Gone Wrong: Credit, Stock Prices, and Germany's Black Friday 1927

Stefan Gissler, Board of Governors of the Federal Reserve

Basel III C: Internal Risk Models

Christian McNamara, Yale University - Yale Program on Financial Stability
Karen Braun-Munzinger, Bank of England
Andrew Metrick, Yale School of Management, National Bureau of Economic Research (NBER)

Optimization of Post-Scoring Classification and Impact on Regulatory Capital for Low Default Portfolios

Benoit Genest, Chappuis Halder & Cie. - London Office
Ziad Fares, Chappuis Halder & Cie. - New York Office

Basel III D: Swiss Finish to Basel III

Christian McNamara, Yale University - Yale Program on Financial Stability
Natalia Tente, Deutsche Bundesbank
Andrew Metrick, Yale School of Management, National Bureau of Economic Research (NBER)


REGULATION OF FINANCIAL INSTITUTIONS eJOURNAL

"Basel III B: Basel III Overview" Free Download
Yale Program on Financial Stability Case Study 2014-1B-V1

CHRISTIAN MCNAMARA, Yale University - Yale Program on Financial Stability
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MICHAEL WEDOW, European Central Bank (ECB) - Directorate Financial Stability and Supervision, Deutsche Bundesbank
Email:
ANDREW METRICK, Yale School of Management, National Bureau of Economic Research (NBER)
Email:

In the wake of the financial crisis of 2007-2009, the Basel Committee on Banking Supervision (BCBS) faced the critical task of diagnosing what went wrong and then updating regulatory standards aimed at preventing it from occurring again. In seeking to strengthen the microprudential regulation associated with the earlier Basel Accords while also adding a macroprudential overlay, Basel III consists of proposals in three main areas intended to address 1) capital reform, 2) liquidity standards, and 3) systemic risk and interconnectedness. This case considers the causes of the 2007-2009 financial crisis and what they suggest about weaknesses in the Basel regime as it then existed. It then summarizes the provisions of Basel III to allow for an evaluation of whether it was an effective response to the causes of the financial crisis.

"Dynamic Stress Test Diffusion Model Considering the Credit Score Performance" Free Download

ZIAD FARES, Chappuis Halder & Cie. - New York Office
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BENOIT GENEST, Chappuis Halder & Cie. - London Office
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ARNAULT GOMBERT, Chappuis Halder & Cie. - Global Research & Analytics Department

After the crisis of 2008, and the important losses and shortfall in capital that it revealed, regulators conducted massive stress testing exercises in order to test the resilience of financial institutions in times of stress conditions. In this context, and considering the impact of these exercises on the banks’ capital, organization and image, this white paper proposes a methodology that diffuses dynamically the stress on the credit rating scale while considering the performance of the credit score. Consequently, the aim is to more accurately reflect the impact of the stress on the portfolio by taking into account the purity of the score and its ability to precisely rank the individuals of the portfolio.

"A Margin Call Gone Wrong: Credit, Stock Prices, and Germany's Black Friday 1927" Free Download

STEFAN GISSLER, Board of Governors of the Federal Reserve
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Leverage is often seen as villain in financial crises. Sudden deleveraging may lead to fire sales and price pressure when asset demand is downward-sloping. This paper looks at the effects of changes in leverage on asset prices. It provides a historical case study where a large, well-identified shock to margin credit disrupted the German stock market. In May 1927, the German central bank forced banks to cut margin lending to their clients. However, this shock affected banks differentially; the magnitude of credit change differed across banks. Using the strong connections between banks and firms in interwar Germany, I show in a difference-in-differences framework that stocks affiliated with affected banks decreased over 12 percent during 4 weeks. Volatility of these stocks doubled. Relating directly bank balance sheet information to asset prices, this paper finds that a one standard deviation decrease in lending to investors increased an affected stock's volatility by 0.22 standard deviations. These results are robust to the problem that banks' lending decisions may be influenced by asset prices. The Reichsbank threatened banks to cut their short-run funding. Using the differences in exposure towards this threat, an instrumental variable strategy provides further evidence that a sharp decrease in leverage may lead to stock price fluctuations.

"Basel III C: Internal Risk Models" Free Download
Yale Program on Financial Stability Case Study 2014-1C-V1

CHRISTIAN MCNAMARA, Yale University - Yale Program on Financial Stability
Email:
KAREN BRAUN-MUNZINGER, Bank of England
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ANDREW METRICK, Yale School of Management, National Bureau of Economic Research (NBER)
Email:

For financial regulators seeking to use regulatory requirements to manage risk in a banking system, there can be a concern that such requirements crowd out efforts by banks to develop their own risk management systems. One way in which regulators have attempted to solve this problem is to enable banks to use internal risk models to satisfy regulatory requirements. Beginning with the 1996 Market Risk Amendment, the Basel framework has allowed banks to determine the capital charges associated with certain assets using their own internal risk models. But allowing the use of internal risk models has not been without controversy. Where some see an incentive for the development of internal risk management systems better able to address the unique risk profiles of particular banks, others see excessive complexity and uncertainty. And while some financial regulators are beginning to subject banks’ models to greater scrutiny, questions remain about the ability of financial regulators to provide effective oversight of such models.

"Optimization of Post-Scoring Classification and Impact on Regulatory Capital for Low Default Portfolios" Free Download

BENOIT GENEST, Chappuis Halder & Cie. - London Office
Email:
ZIAD FARES, Chappuis Halder & Cie. - New York Office
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After the crisis of 2008, new regulatory requirements have emerged with supervisors strengthening their position in terms of requirements to meet IRBA standards. Low Default Portfolios (LDP) present specific characteristics that raise challenges for banks when building and implementing credit risk models. In this context, where banks are looking to improve their Return On Equity and supervisors strengthening their positions, this paper aims to provide clues for optimizing Post-Scoring classification as well as analyzing the relationship between the number of classes in a rating scale and the impact on regulatory capital for LDPs.

"Basel III D: Swiss Finish to Basel III" Free Download
Yale Program on Financial Stability Case Study 2014-1D-V1

CHRISTIAN MCNAMARA, Yale University - Yale Program on Financial Stability
Email:
NATALIA TENTE, Deutsche Bundesbank
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ANDREW METRICK, Yale School of Management, National Bureau of Economic Research (NBER)
Email:

After the Basel Committee on Banking Supervision (BCBS) introduced the Basel III framework in 2010, individual countries confronted the question of how best to implement the framework given their unique circumstances. Switzerland, with a banking industry that is both heavily concentrated and very large relative to the size of its overall economy, faced a special challenge. It ultimately adopted what is sometimes referred to as the “Swiss Finish? to Basel III – enhanced requirements applicable to Switzerland’s “too-big-to-fail? banks Credit Suisse and UBS that go beyond the base requirements established by the BCBS. Yet the prominent role played by relatively new contingent convertible capital (CoCos) in the Swiss Finish, coupled with the fact that banks are allowed to use their own internal models in determining whether requirements are met may call into question the extent to which the Swiss Finish to Basel III represents a meaningful enhancement to the risk-based capital requirements of the Basel framework.

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This eJournal distributes working and accepted paper abstracts covering regulatory and legal aspects of national and international financial institutions. The eJournal welcomes research that deals with legal aspects of depository institutions including banks, credit unions, trust companies, and mortgage loan companies. Topics also include regulation of insurance companies, brokers, underwriters, and investment funds.

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BANKING & FINANCIAL INSTITUTIONS EJOURNALS

MICHAEL C. JENSEN
Social Science Electronic Publishing (SSEP), Inc., Harvard Business School, National Bureau of Economic Research (NBER), European Corporate Governance Institute (ECGI)
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Advisory Board

Regulation of Financial Institutions eJournal

EDWARD I. ALTMAN
Max L. Heine Professor of Finance and Vice Director, New York University (NYU) - Salomon Center, Max L. Heine Professor of Finance, New York University (NYU) - Department of Finance

DENNIS R. CAPOZZA
Professor of Finance and Dykema Professor of Business Administration, University of Michigan, Stephen M. Ross School of Business

DONALD CHEW
Morgan Stanley Investment Management

J. DAVID CUMMINS
Joseph E. Boettner Professor, Temple University - Risk Management & Insurance & Actuarial Science

DOUGLAS W. DIAMOND
Merton H. Miller Distinguished Service Professor of Finance, University of Chicago - Booth School of Business, National Bureau of Economic Research (NBER)

EUGENE F. FAMA
Robert R. McCormick Distinguished Service Professor of Finance, University of Chicago - Finance

STEPHEN FIGLEWSKI
Professor of Finance, New York University - Stern School of Business

STUART I. GREENBAUM
Bank of America Professor of Managerial Leadership, Washington University in St. Louis - Olin Business School

MICHAEL C. JENSEN
Co-Founder, Chairman, Managing Director and Integrity Officer, Social Science Electronic Publishing (SSEP), Inc., Jesse Isidor Straus Professor of Business Administration, Emeritus, Harvard Business School, Research Associate, National Bureau of Economic Research (NBER), Fellow, European Corporate Governance Institute (ECGI)

JONATHAN M. KARPOFF
Washington Mutual Endowed Chair in Innovation Professor of Finance, University of Washington - Michael G. Foster School of Business

KENNETH LEHN
Professor of Business Administration, University of Pittsburgh - Finance Group

STANLEY R. PLISKA
University of Illinois at Chicago - Department of Finance

CHARLES I. PLOSSER
President, Federal Reserve Bank of Philadelphia, National Bureau of Economic Research (NBER)

KATHERINE SCHIPPER
Duke University - Fuqua School of Business

ALAN SCHWARTZ
Sterling Professor of Law, Yale Law School

G. WILLIAM SCHWERT
Distinguished University Professor of Finance and Statistics, University of Rochester - Simon Business School, National Bureau of Economic Research (NBER)

RENE M. STULZ
Everett D. Reese Chair of Banking and Monetary Economics, Ohio State University (OSU) - Department of Finance, National Bureau of Economic Research (NBER), Fellow, European Corporate Governance Institute (ECGI)

ROSS L. WATTS
Erwin H. Schell Professor of Management, Massachusetts Institute of Technology (MIT) - Sloan School of Management