Value-at-Risk vs. Building Block Regulation in Banking

55 Pages Posted: 28 Oct 2000

See all articles by Thomas Dangl

Thomas Dangl

Vienna University of Technology

Alfred Lehar

University of Calgary - Haskayne School of Business

Date Written: August 2002

Abstract

Existing regulatory capital requirements are often criticized for being only loosely linked to the economic risk of the banks' assets. In view of the attempts of international regulators to introduce more risk sensitivene capital requirements, we theoretically examine the effect of specific regulatory capital requirements on the risk taking behavior of banks. More precisely, we develop a continuous time framework where the banks' choice of asset risk is endogenously determined. We compare regulation based on the Basel I Building Block approach to Value-at-Risk or 'internal model' based capital requirements with respect to risk taking behavior, deposit insurance liability, and shareholder value. The main findings are (i) Value-at-Risk based capital regulation creates a stronger incentive to reduce asset risk when banks are solvent, (ii) solvent banks that reduce their asset risk reduce the current value of the deposit insurance liability significantly, (iii) under Value-at-Risk regulation the risk reduction behavior of banks is less sensitive to changes in their investment opportunity set, and (iv) banks' equityholders can benefit from risk based capital requirements.

Note: Previously titled Basle Accord vs. Value-at-Risk Regulation in Banking

JEL Classification: G21, G28, G12

Suggested Citation

Dangl, Thomas and Lehar, Alfred, Value-at-Risk vs. Building Block Regulation in Banking (August 2002). Available at SSRN: https://ssrn.com/abstract=243652 or http://dx.doi.org/10.2139/ssrn.243652

Thomas Dangl (Contact Author)

Vienna University of Technology ( email )

Theresianumgasse 27
Vienna, A-1040
Austria

Alfred Lehar

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/

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