Macroprudential Regulation: A Risk Management Approach

Abstract

We use market-based estimates of systemic risk and a structural framework for credit risk assessment to address the problem of regulating banks’ macroprudential capital buffers. We sketch three approaches to allocating capital buffers across systemic banks: equalizing the expected impact between systemic and non-systemic institutions, minimizing aggregate systemic risk, and balancing the social costs and benefits of capital requirements. In our application to the European banking sector we find substantial differences with current capital requirements. Capital buffers play a key role in managing banks’ contributions to systemic distress, so our findings have material implications for systemic risk in the EEA.

Keywords: systemic risk, regulation, capital buffers, implied market measures, financial institutions, CDS

JEL Classification: G01, G20, G18, G38