Bank Capital Allocation under Multiple Constraints

32 Pages Posted: 10 Nov 2017

See all articles by Tirupam Goel

Tirupam Goel

Bank for International Settlements (BIS)

Ulf Lewrick

Bank for International Settlements (BIS) - Monetary and Economic Department; University of Basel - Faculty of Business and Economics

Nikola A. Tarashev

Bank for International Settlements (BIS) - Monetary and Economic Department

Date Written: October 2017

Abstract

Banks allocate capital across business units while facing multiple constraints that may bind contemporaneously or only in future states. When risks rise or risk management strengthens, a bank reallocates capital to the more efficient unit. This unit would have generated higher constraint- and risk-adjusted returns while satisfying a tightened constraint at the old capital allocation. Calibrated to US data, our model reveals that, when credit or market risk increases, market-making attracts capital and lending shrinks. Leverage constraints affect banks only when measured risks are low. At low credit risk, tighter leverage constraints may reduce market-making but support lending.

Keywords: internal capital market, Value-at-Risk, leverage ratio, risk-adjusted return on capital

JEL Classification: G21, G28, G3

Suggested Citation

Goel, Tirupam and Lewrick, Ulf and Tarashev, Nikola A., Bank Capital Allocation under Multiple Constraints (October 2017). BIS Working Paper No. 666, Available at SSRN: https://ssrn.com/abstract=3062943

Tirupam Goel (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Ulf Lewrick

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

University of Basel - Faculty of Business and Economics ( email )

Petersplatz 1
Basel, 4001
Switzerland

Nikola A. Tarashev

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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