Capital Adequacy Tests and Limited Liability of Financial Institutions

26 Pages Posted: 2 Nov 2013 Last revised: 5 Nov 2015

See all articles by Pablo Koch-Medina

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

Date Written: January 29, 2014

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

JEL Classification: C60, G11, G22

Suggested Citation

Koch-Medina, Pablo and Moreno-Bromberg, Santiago and Munari, Cosimo, Capital Adequacy Tests and Limited Liability of Financial Institutions (January 29, 2014). Journal of Banking & Finance, 51 (2015). Available at SSRN: https://ssrn.com/abstract=2348590 or http://dx.doi.org/10.2139/ssrn.2348590

Pablo Koch-Medina

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Santiago Moreno-Bromberg (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Andreasstrasse 15
Zürich, 8050
Switzerland

Cosimo Munari

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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