IDEAS home Printed from https://ideas.repec.org/p/zbw/bubdps/092012.html
   My bibliography  Save this paper

Bank regulation and stability: An examination of the Basel market risk framework

Author

Listed:
  • Alexander, Gordon J.
  • Baptista, Alexandre M.
  • Yan, Shu

Abstract

In attempting to promote bank stability, the Basel Committee on Banking Supervision (2006) provides a framework that seeks to control the amount of tail risk that large banks take in their trading books. However, banks around the world suffered sizeable trading losses during the recent crisis. Due to the size and prevalence of losses, a formal examination of whether the Basel framework allows banks to take substantive tail risk in their trading books without a capital requirement penalty is of particular interest. In this paper, we provide such an examination and show that the Basel framework indeed allows banks to do so. Hence, our paper supports the view that the Basel framework leaves room for considerable improvements regarding the treatment of tail risk.

Suggested Citation

  • Alexander, Gordon J. & Baptista, Alexandre M. & Yan, Shu, 2012. "Bank regulation and stability: An examination of the Basel market risk framework," Discussion Papers 09/2012, Deutsche Bundesbank.
    • Handle: RePEc:zbw:bubdps:092012
    as

    Download full text from publisher

    File URL: https://www.econstor.eu/bitstream/10419/57780/1/715123149.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Gordon J. Alexander & Alexandre M. Baptista, 2004. "A Comparison of VaR and CVaR Constraints on Portfolio Selection with the Mean-Variance Model," Management Science, INFORMS, vol. 50(9), pages 1261-1273, September.
    2. Jian Cai & Kent Cherny & Todd T. Milbourn, 2010. "Compensation and risk incentives in banking and finance," Economic Commentary, Federal Reserve Bank of Cleveland, issue Sep.
    3. Barth,James R. & Caprio,Gerard & Levine,Ross, 2008. "Rethinking Bank Regulation," Cambridge Books, Cambridge University Press, number 9780521709309, January.
    4. Mathias Dewatripont & Jean-Charles Rochet & Jean Tirole, 2010. "Lessons from the Crisis," Introductory Chapters, in: Balancing the Banks: Global Lessons from the Financial Crisis, Princeton University Press.
    5. Koehn, Michael & Santomero, Anthony M, 1980. "Regulation of Bank Capital and Portfolio Risk," Journal of Finance, American Finance Association, vol. 35(5), pages 1235-1244, December.
    6. René Garcia & Éric Renault & Georges Tsafack, 2007. "Proper Conditioning for Coherent VaR in Portfolio Management," Management Science, INFORMS, vol. 53(3), pages 483-494, March.
    7. Kane, Edward J., 2006. "Inadequacy of nation-based and VaR-based safety nets in the European Union," The North American Journal of Economics and Finance, Elsevier, vol. 17(3), pages 375-387, December.
    8. Pritsker, Matthew, 2006. "The hidden dangers of historical simulation," Journal of Banking & Finance, Elsevier, vol. 30(2), pages 561-582, February.
    9. Pérignon, Christophe & Smith, Daniel R., 2010. "The level and quality of Value-at-Risk disclosure by commercial banks," Journal of Banking & Finance, Elsevier, vol. 34(2), pages 362-377, February.
    10. Bing Liang & Hyuna Park, 2007. "Risk Measures for Hedge Funds: a Cross‐sectional Approach," European Financial Management, European Financial Management Association, vol. 13(2), pages 333-370, March.
    11. Rochet, Jean-Charles, 1992. "Capital requirements and the behaviour of commercial banks," European Economic Review, Elsevier, vol. 36(5), pages 1137-1170, June.
    12. Mathias Dewatripont & Jean-Charles Rochet & Jean Tirole, 2015. "Balancing the Banks: Global Lessons from the Financial Crisis," Economics Books, Princeton University Press, edition 1, number 9155.
    13. Ross Levine, 2010. "An autopsy of the US financial system: accident, suicide, or negligent homicide," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 2(3), pages 196-213, August.
    14. Alexander, Gordon J. & Baptista, Alexandre M., 2009. "Stress testing by financial intermediaries: Implications for portfolio selection and asset pricing," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 65-92, January.
    15. Barth, James R. & Caprio, Gerard Jr. & Levine, Ross, 2004. "Bank regulation and supervision: what works best?," Journal of Financial Intermediation, Elsevier, vol. 13(2), pages 205-248, April.
    16. Xavier Freixas & Jean-Charles Rochet, 2008. "Microeconomics of Banking, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062704, December.
    17. repec:bla:jfinan:v:43:y:1988:i:5:p:1219-33 is not listed on IDEAS
    18. Rockafellar, R. Tyrrell & Uryasev, Stanislav, 2002. "Conditional value-at-risk for general loss distributions," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1443-1471, July.
    19. Lucas, Andre, 2001. "Evaluating the Basle Guidelines for Backtesting Banks' Internal Risk Management Models," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(3), pages 826-846, August.
    20. Liang, Bing & Park, Hyuna, 2010. "Predicting Hedge Fund Failure: A Comparison of Risk Measures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 45(1), pages 199-222, February.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Thomas Theobald, 2015. "Agent-based risk management – a regulatory approach to financial markets," Journal of Economic Studies, Emerald Group Publishing Limited, vol. 42(5), pages 780-820, October.
    2. Gyöngyi Bugár & Anita Ratting, 2016. "Revision of the quantification of market risk in the Basel III regulatory framework," Financial and Economic Review, Magyar Nemzeti Bank (Central Bank of Hungary), vol. 15(1), pages 33-50.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Alexander, Gordon J. & Baptista, Alexandre M. & Yan, Shu, 2012. "When more is less: Using multiple constraints to reduce tail risk," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2693-2716.
    2. Alexander, Gordon J. & Baptista, Alexandre M. & Yan, Shu, 2014. "Bank regulation and international financial stability: A case against the 2006 Basel framework for controlling tail risk in trading books," Journal of International Money and Finance, Elsevier, vol. 43(C), pages 107-130.
    3. Alexander, Gordon J. & Baptista, Alexandre M. & Yan, Shu, 2013. "A comparison of the original and revised Basel market risk frameworks for regulating bank capital," Journal of Economic Behavior & Organization, Elsevier, vol. 85(C), pages 249-268.
    4. Alexander, Gordon J. & Baptista, Alexandre M. & Yan, Shu, 2021. "Regulation of bank proprietary trading post 2007–09 crisis: An examination of the Basel framework and Volcker rule," Journal of International Money and Finance, Elsevier, vol. 119(C).
    5. Gordon J. Alexander & Alexandre M. Baptista, 2017. "Bank Capital Regulation of Trading Portfolios: An Assessment of the Basel Framework," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(4), pages 603-634, June.
    6. Gordon J. Alexander & Alexandre M. Baptista & Shu Yan, 2015. "On Regulatory Responses to the Recent Crisis: An Assessment of the Basel Market Risk Framework and the Volcker Rule," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 24(2-3), pages 87-125, May.
    7. Anginer, Deniz & Demirgüç-Kunt, Asli & Mare, Davide S., 2018. "Bank capital, institutional environment and systemic stability," Journal of Financial Stability, Elsevier, vol. 37(C), pages 97-106.
    8. Ralf Bebenroth & Diemo Dietrich & Uwe Vollmer, 2009. "Bank regulation and supervision in bank-dominated financial systems: a comparison between Japan and Germany," European Journal of Law and Economics, Springer, vol. 27(2), pages 177-209, April.
    9. Ashraf, Badar Nadeem & Zheng, Changjun & Jiang, Chonghui & Qian, Ningyu, 2020. "Capital regulation, deposit insurance and bank risk: International evidence from normal and crisis periods," Research in International Business and Finance, Elsevier, vol. 52(C).
    10. Marcelo Brutti Righi & Paulo Sergio Ceretta, 2015. "Shortfall Deviation Risk: An alternative to risk measurement," Papers 1501.02007, arXiv.org, revised May 2016.
    11. Farkas, Walter & Fringuellotti, Fulvia & Tunaru, Radu, 2020. "A cost-benefit analysis of capital requirements adjusted for model risk," Journal of Corporate Finance, Elsevier, vol. 65(C).
    12. Muhammad Suhail Rizwan & Muhammad Moinuddin & Barbara L’Huillier & Dawood Ashraf, 2018. "Does a one-size-fits-all approach to financial regulations alleviate default risk? The case of dual banking systems," Journal of Regulatory Economics, Springer, vol. 53(1), pages 37-74, February.
    13. David VanHoose, 2006. "Bank Behavior Under Capital Regulation: What Does The Academic Literature Tell Us?," NFI Working Papers 2006-WP-04, Indiana State University, Scott College of Business, Networks Financial Institute.
    14. Ayadi, Rym & De Groen, Willem Pieter, 2014. "Banking Business Models Monitor 2014: Europe," CEPS Papers 9713, Centre for European Policy Studies.
    15. Cihak, Martin & Demirguc-Kunt, Asli & Peria, Maria Soledad Martinez & Mohseni-Cheraghlou, Amin, 2012. "Bank regulation and supervision around the world : a crisis update," Policy Research Working Paper Series 6286, The World Bank.
    16. Laeven, Luc & Levine, Ross, 2009. "Bank governance, regulation and risk taking," Journal of Financial Economics, Elsevier, vol. 93(2), pages 259-275, August.
    17. Ongena, Steven & Popov, Alexander & Udell, Gregory F., 2013. "“When the cat's away the mice will play”: Does regulation at home affect bank risk-taking abroad?," Journal of Financial Economics, Elsevier, vol. 108(3), pages 727-750.
    18. Borgonovo, Emanuele & Gatti, Stefano, 2013. "Risk analysis with contractual default. Does covenant breach matter?," European Journal of Operational Research, Elsevier, vol. 230(2), pages 431-443.
    19. Andersen, Torben G. & Bollerslev, Tim & Christoffersen, Peter F. & Diebold, Francis X., 2013. "Financial Risk Measurement for Financial Risk Management," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1127-1220, Elsevier.
    20. Monika Marcinkowska, 2013. "Regulation and self-regulation in banking: in search of optimum," Bank i Kredyt, Narodowy Bank Polski, vol. 44(2), pages 119-158.

    More about this item

    Keywords

    Bank regulation; bank stability; Basel framework; crisis; tail risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:zbw:bubdps:092012. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ZBW - Leibniz Information Centre for Economics (email available below). General contact details of provider: https://edirc.repec.org/data/dbbgvde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.