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Diversification, protection of liability holders and regulatory arbitrage

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  • Pablo Koch-Medina
  • Cosimo Munari
  • Mario Sikic

Abstract

Any solvency regime for financial institutions should be aligned with the fundamental objectives of regulation: protecting liability holders and securing the stability of the financial system. The first objective leads to consider surplus-invariant capital adequacy tests, i.e. tests that do not depend on the surplus of a financial institution. We provide a complete characterization of closed, convex, surplus-invariant capital adequacy tests that highlights an inherent tension between surplus-invariance and the desire to give credit for diversification. The second objective leads to requiring consistency of capital adequacy tests across jurisdictions. Of particular importance in this respect are capital adequacy tests that remain invariant under a change of num\'{e}raire. We establish an intimate link between surplus- and num\'{e}raire invariant tests.

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  • Pablo Koch-Medina & Cosimo Munari & Mario Sikic, 2015. "Diversification, protection of liability holders and regulatory arbitrage," Papers 1502.03252, arXiv.org, revised Apr 2016.
    • Handle: RePEc:arx:papers:1502.03252
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    Cited by:

    1. Xue Dong He & Xianhua Peng, 2017. "Surplus-Invariant, Law-Invariant, and Conic Acceptance Sets Must be the Sets Induced by Value-at-Risk," Papers 1707.05596, arXiv.org, revised Jan 2018.
    2. Koch-Medina, Pablo & Munari, Cosimo, 2016. "Unexpected shortfalls of Expected Shortfall: Extreme default profiles and regulatory arbitrage," Journal of Banking & Finance, Elsevier, vol. 62(C), pages 141-151.

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