Regulatory Capital and Incentives for Risk Model Choice under Basel 3

55 Pages Posted: 12 Aug 2020

See all articles by Fred Liu

Fred Liu

University of Guelph; University of Western Ontario, Department of Economics

Lars Stentoft

Department of Economics, University of Western Ontario; Center for Interuniversity Research and Analysis on Organization (CIRANO); Aarhus University - CREATES

Date Written: July 14, 2020

Abstract

In response to the Subprime Mortgage crisis, the Basel Committee on Banking Supervision (BCBS) has spent the previous decade overhauling the regulatory framework that governs how banks calculate minimum capital requirements. In 2019, the BCBS finalized the Basel 3 regulatory regime, which changes the regulatory measure of market risk and adds new complex calculations based on liquidity and risk factors. This paper is motivated by these changes and seeks to answer the question of how regulation affects banks' choice of risk-management models, whether it incentivizes them to use correctly specified models, and if it results in more stable capital requirements. Our results show that, although the models that minimize regulatory capital for a representative bank portfolio also result in the most stable requirements, these models are generally rejected as being correctly specified and tend to produce inferior forecasts of the regulatory risk measures.

Keywords: Basel 3, Expected Shortfall Backtesting, Regulatory Capital Requirements

JEL Classification: C14, C22, C53, G32

Suggested Citation

Liu, Fred and Stentoft, Lars, Regulatory Capital and Incentives for Risk Model Choice under Basel 3 (July 14, 2020). Available at SSRN: https://ssrn.com/abstract=3651455 or http://dx.doi.org/10.2139/ssrn.3651455

Fred Liu

University of Guelph ( email )

50 Stone Road East
Guelph, Ontario N1G 2W1
Canada

University of Western Ontario, Department of Economics ( email )

London, Ontario
Canada

Lars Stentoft (Contact Author)

Department of Economics, University of Western Ontario ( email )

London, Ontario N6A 5B8
Canada

Center for Interuniversity Research and Analysis on Organization (CIRANO)

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

Aarhus University - CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
176
Abstract Views
933
Rank
290,120
PlumX Metrics