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Macroprudential Capital Requirements and Systemic Risk

35 Pages Posted: 23 Aug 2010 Last revised: 23 Dec 2010

Celine Gauthier

Government of Canada - Bank of Canada

Alfred Lehar

University of Calgary - Haskayne School of Business

Moez Souissi

Government of Canada - Bank of Canada

Date Written: December 2010

Abstract

When regulating banks based on their contribution to the overall risk of the banking system we have to consider that the risk of the banking system as well as each bank's risk contribution changes once bank equity capital gets reallocated. We define macroprudential capital requirements as the fixed point at which each bank's capital requirement equals its contribution to the risk of the system under the proposed capital requirements. This study uses two alternative models, a network based framework and a Merton model, to measure systemic risk and how it changes with bank capital and allocates risk to individual banks based on five risk allocation mechanisms used in the literature. Using a sample of Canadian banks we find that macroprudential capital allocations can differ by as much as 70% from observed capital levels, are not trivially related to bank size or individual bank default probability, increase in interbank assets, and differ substantially from a simple risk attribution analysis. We further find that across both models and all risk allocation mechanisms that macroprudential capital requirements reduce the default probabilities of individual banks as well as the probability of a systemic crisis by about 25%. Macroprudential capital requirements are robust to model risk and are positively correlated to future capital raised by banks as well as future losses in equity value. Our results suggest that financial stability can be substantially enhanced by implementing a systemic perspective on bank regulation.

Keywords: Systemic Risk, Financial Stability, Bank regulation, Risk Management, Inter-bank Market

JEL Classification: G21, C15, C81

Suggested Citation

Gauthier, Celine and Lehar, Alfred and Souissi, Moez, Macroprudential Capital Requirements and Systemic Risk (December 2010). Available at SSRN: https://ssrn.com/abstract=1663993 or http://dx.doi.org/10.2139/ssrn.1663993

Celine Gauthier

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

Alfred Lehar (Contact Author)

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada
403-220-4567 (Phone)

HOME PAGE: http://homepages.ucalgary.ca/~alehar/

Moez Souissi

Government of Canada - Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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