Bank Regulation and International Financial Stability: A Case Against the 2006 Basel Framework for Controlling Tail Risk in Trading Books

Journal of International Money and Finance, Vol. 43, pp. 107-130, May 2014

Posted: 18 Jul 2017

See all articles by Gordon J. Alexander

Gordon J. Alexander

University of Minnesota - Twin Cities - Carlson School of Management

Alexandre M. Baptista

George Washington University - School of Business

Shu Yan

Oklahoma State University - Stillwater - Department of Finance

Date Written: July 12, 2017

Abstract

In attempting to promote international financial stability, the Basel Committee on Banking Supervision (2006) provided a framework that sought to control the amount of tail risk that large banks around the world would take in their trading books relative to their corresponding minimum capital requirements. However, many of these banks suffered significant trading losses during the recent financial crisis. Our paper examines whether the Basel framework allowed banks to take substantive tail risk in their trading books without a capital requirement penalty. We find that it allowed banks to do so and that its minimum capital requirements can be notably procyclical. Hence, focusing on the way the Basel framework sought to control the amount of tail risk in trading books relative to their corresponding minimum capital requirements, our paper supports the view that it was not properly designed to promote financial stability. We also discuss alternative regulatory frameworks that would potentially be more effective than the Basel framework in preventing banks from taking substantive tail risk in their trading books without a capital requirement penalty.

Keywords: Bank regulation, Financial stability, Basel framework, Financial crisis, Tail risk

JEL Classification: G11, G21, G28, D81

Suggested Citation

Alexander, Gordon J. and Baptista, Alexandre M. and Yan, Shu, Bank Regulation and International Financial Stability: A Case Against the 2006 Basel Framework for Controlling Tail Risk in Trading Books (July 12, 2017). Journal of International Money and Finance, Vol. 43, pp. 107-130, May 2014. Available at SSRN: https://ssrn.com/abstract=3001168

Gordon J. Alexander

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States
612-624-8598 (Phone)
612-624-1335 (Fax)

Alexandre M. Baptista (Contact Author)

George Washington University - School of Business ( email )

School of Business, Funger Hall, Suite 501
2201 G Street, NW
Washington, DC 20052
United States
202-994-3309 (Phone)
202-994-5014 (Fax)

HOME PAGE: http://home.gwu.edu/~alexbapt/

Shu Yan

Oklahoma State University - Stillwater - Department of Finance ( email )

Spears School of Business
Stillwater, OK 74078-4011
United States

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