Measuring the Capital Shortfall of Large U.S. Banks

Abstract

We develop a methodology to measure the capital shortfall of commercial banks in a market downturn, which we call stressed expected loss (SEL). We simulate a market downturn as a negative shock on interest rate and credit market risk factors that reflect the banks’ market-sensitive assets. We measure SEL as the difference between the mark-to-market value of the assets in the downturn and the book value of the liabilities. Based on large U.S. commercial banks, we empirically demonstrate that individual SEL predicts the loss of capital projected by banks in a severely adverse scenario and that aggregate SEL predicts macroeconomic variables.

Keywords: Systemic Risk, Capital Shortfall, Stress Test, Multifactor Model

JEL Classification: C32, G01, G21, G28, G32