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Assessing the Long-Term Effects of Bank Policies

32 Pages Posted: 28 May 2014  

John R. Birge

University of Chicago - Booth School of Business

Pedro Júdice

Business Research Unit, Instituto Superior de Ciencias do Trabalho e da Empresa (ISCTE)

Date Written: May 27, 2014

Abstract

Current risk management frameworks are not suitable for testing the long-term implications of balance sheet policies. The current established methodologies, such as interest rate gap analysis or Credit Value-at-Risk are short-term and do not give a clear picture of the long-term risk of a bank. Backtesting is also difficult, given that the data is limited, thus not producing risk measures for long-term policies. Therefore, simulation is the best option for assessing the long-term implications of regulatory and management choices.

In a previous note, we developed a scenario generation tool for simulating the long-term behavior of balance sheets of banks. In this note, we use this framework to quantify the long-term impact on risk and return of the leverage ratio, the core deposit ratio, operating costs and interest rates. As Basel III is being implemented, our tests confirm the benefits of holding a cushion of capital above the leverage ratio limit of 3%, a policy similar to the one followed by banks under previous regulation. Also, banks should consider setting a conservative limit for the core deposit ratio.

Suggested Citation

Birge, John R. and Júdice, Pedro, Assessing the Long-Term Effects of Bank Policies (May 27, 2014). Available at SSRN: https://ssrn.com/abstract=2442194 or http://dx.doi.org/10.2139/ssrn.2442194

John R. Birge

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Pedro Júdice (Contact Author)

Business Research Unit, Instituto Superior de Ciencias do Trabalho e da Empresa (ISCTE) ( email )

Complexo Indeg/Iscte
Av. Professor Anibal Bettencourt
Lisboa, 1600-189
Portugal

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