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The recently finalised Basel Framework continues to allow banks to use internal data and models to define risk estimates and use them to compute their capital adequacy ratios. Globally, there are more than two thousand banks running Basel internal models. However, there are countries that have no such banks. They face the dilemma of which of the transition paths to adopt: the voluntary path, as in the EU, or the mandatory path, as in the US. Our objective is to take an investor’s perspective and benchmark the two modes. Thus, we wish to determine whether there is a premium for either of them or whether they are, perhaps, equivalent. The novelty of our research is in its robust estimate that investors prefer a mandatory transition to a voluntary one if we consider the period of the 2007–2009 crisis. However, the use of the common post-crisis sample yields the opposite conclusion. A voluntary transition is preferred, though it implies a rise in stock volatility, and thus, the overall risk-return relationship is preserved. This is mostly driven by the tighter used when adopting internal models in the US compared to the EU. European banks have had more room to expand their business after the IRB transition, while for US banks, the transition involved a reduction in business, all else being equal. Our findings are of value primarily to emerging economies such as Argentina or Indonesia.

Introduction: COVID-19 pandemic raised the stability challenges for the modern banking systems. As a remedy, the regulators and investors turned their eyes to the Islamic Banking. Many people view it as a full substitute to the dominant conventional banking establishments. We hypothesized that the benefits of the Islamic Banking can be fully enjoyed if and only if it is accompanied with the robust regulatory framework. Such a framework could offer room for the national discretion to define ‘alpha’ parameter within the capital adequacy ratio. The novelty of our paper is the largest collected to date set of alpha value embedded in the Islamic Banking jurisdictions. Purpose: This research paper aims to able to identify the core driver to locally determine the value of alpha. The credit-to-GDP ratio was shown to be such a driver. We demonstrated that the earlier academic research had offered the Vasicek-based theoretical models for the Islamic Banking that had implied right the opposite values of alpha. Methodology: We have eight independent determinants with presenting the alpha values for 11 countries registered in 2007 and in 2016.Those are the four macroeconomic variables. we have collected the input data for the regression model. Findings: The credit-to-GDP ratio was shown to be such a driver. We demonstrated that the earlier academic research had offered the Vasicek-based theoretical models for the Islamic Banking that had implied right the opposite values of alpha. Thus, the usage of the determinant revealed by us could be of help to the central bankers when shaping the framework for Islamic Banking capital adequacy. Paper Type: Research Article

The Bank of Russia is one of the unique banking regulators in the world as it discloses granular reporting information per the existing credit institutions with the available historical track record. Same time the number of banks dramatically declined from above two and a half thousands in 1990s to one thousand in 2010 and to around 350 in 2021. Such information stimulates designing default probability (PD) models for the Russian banks. There is a separate stream of research that studies the amount of negative capital revealed when the Russian bank got its license withdrawn. However, the existing papers have several shortcomings. First, most of them do not account for the structural breaks in data. Second, there is no search for the best fitting model, just a model is offered and the coefficients of interest are interpreted. Third, the best model is poorly interpretable. Forth, the existing models make short-term forecasts. Fifth, there is no a LGD model for Russian banks, though the amount of negative capital upon license withdrawal was considered. Thus, our research objective is to study PD-LGD correlation (PLC) for the Russian banks. To do so, we improve the existing Russian banks PD model and create a respective novel LGD model. We use the homogenous dataset from 2016 to 2021. We find that PLC for Russian banks equals to +22%.

COVID-19 pandemic challenges the sustainability of the modern financial system. International central bankers claim that banks are solid. They have accumulated significant capital buffers. Those buffers should be further more augmented by 2027 in line with Basel III reforms. However, disregarding such a consecutive rise in the banking capital adequacy requirements, the US financial authorities undertook an unprecedented step. First time in the country history they lowered the reserve requirement to zero at the end of March 2020. Friedrich von Hayek demonstrated the fragility of the modern fractional reserve banking systems. Together with Ludwig von Mises (von Mises, 1978) he was thus able to predict the Great Depression of 1929 and explain its mechanics much in advance. Thus, we wish to utilize the agent-based modeling technique to extend von Hayek’s rationale to the previously unstudied interaction of capital adequacy and reserve requirement regulation. We find that the full reserve requirement regime even without capital adequacy regulation provides more stable financial environment than the existing one. Rise in capital adequacy adds to modern banking sustainability, but it still preserves the system remarkably fragile compared to the full reserve requirement. We also prove that capital adequacy regulation is redundant when the latter environment is in place. We discuss our findings application to the potential Central Bank Digital Currencies regulation.

In the first week of June 2021, the Bank of Russia and the New Economic School hosted a joint international online workshop titled ‘Identification and Measurement of Macroprudential Policies Effects’. Participants’ presentations suggest that macroprudential policy measures against high-risk lending produce their intended effects, but also, as a rule, bring about side effects. These effects may include a reduction in low-risk loan disbursements, if such measures are disincentivising in nature (as in Russia), or, vice versa, significant growth in the portfolio of low-risk loans, if the macroprudential tools are of a restrictive nature (as in Switzerland and Ireland).

The BIS indicated in July 2020 an unprecedented rise in default risk correlation as a result of pandemics-induced credit risks’ accumulation. A third of the world banking assets credit risk measurement depends on the Basel internal-ratings-based (IRB) models. To ensure financial stability, we wish IRB models to be accurate in default probability (PD) forecasting. There naturally arises a question of which model may be deemed accurate if the data demonstrates the presence of the default correlation. The existing prudential IRB validation guidelines suggest a confidence interval of up to 100 percentage points’ length for such a case. Such an interval is useless as any model and any PD forecast seem accurate. The novelty of this paper is the justification for the use of twin confidence intervals to validate PD model accuracy. Those intervals more concentrate around the two extremes (default and its absence), the higher the default correlation is.

The COVID-19 induced the central bankers to search the most efficient stimulus measures. As a solution, they made an unprecedented step. They lifted down the reserve requirement (RR) to zero. This ...

Es probable que la pandemia de 2020 resulte en incumplimientos crediticios masivos. Los reguladores nos aseguran que los bancos son suficientemente estables. Sin embargo, los opositores afirman que la regulación es laxa que debe ser más estricta y que se necesita de manera vital un regulador supranacional. Para resolver este debate, volvemos a los fundamentos del sistema bancario moderno. Analizamos la evolución de la regulación micro y macroprudencial, en especial el riesgo sistémico. Encontramos la solución en la intersección de la teoría del requisito de reserva total para depósitos a la vista de von Hayek (1929) y la teoría de policentricidad de Ostrom (2009), que resulta más eficiente para utilizar de manera óptima los recursos comunes. Desarrollamos las recomendaciones basadas en cuencas hidrográficas de Selmier (2016) para gobernar los mercados financieros y las extendemos a una analogía de flujo de tráfico. Concluimos con recomendaciones operativas para la revisión de la regulación bancaria prudencial existente. Proporcionamos una justificación adicional para la necesidad de un sistema completo de reserva. Esto permite abandonar los sistemas estatales de seguro de depósitos con déficits presupuestarios crónicos.

The Basel Committee on Banking Supervision finalized the Basel III accord in the December 2017 and launched the set of its standards – the Basel Framework – in December 2019. Both documents allow bank to use mathematical models for the credit risk estimation. There are quantitative and qualitative requirements for models to be allowed for use in the prudential regulation of banks. The approach is called an Internal-Ratings-Based one (IRB). This paper aims at discussing a set of issues related to IRB credit risk modeling and such model estimates use. Those issues include data pooling in the credit registries, applying copula-discriminant analysis, validating the borrower concentration per grade, assigning the hybrid credit rating, use of model estimates when voting at the credit committee, estimate of the ultimate credit risk-taking by banks.

The Basel III regulation raised the minimum capital requirements for banks. However, its implementation may not have reduced systemic risks. Academicians investigating optimal banking regulations d...

In contemporary world, binary choice models are used in many areas. However, for all such areas, a problem arises when the share of one of the classes in the data sample is small. If this share is significantly small, this class is referred to as low default class. The purpose of this paper is to examine the definitions of such a portfolio and the approaches to building models on its basis. Although various methods exist for obtaining results, this paper shows that distinguishing a low default portfolio class, on the one hand, benefits banks, as does any more detailed segmentation, but, on the other hand, it deteriorates the statistical properties of the models for the probability of default. It is therefore justified that for the internal rating based approach in the framework of Basel II and Basel III the regulator should require that banks build their models based on combined data sets discouraging them from setting excessive low default portfolio classes.

The objective of this paper is to examine the relationship between bank characteristics, in particular value, performance and volatility of bank stock returns, and its exposure to financial derivative contracts. The study is based on 109 publicly traded European banks over the period from 2005 to 2010. The database contains both accounting data from Bankscope and manually collected information from the notes to financial statements. After controlling for bank-specific characteristics, time effects and cross-country differences, we find that banks efficiently using hedging derivatives have a lower risk and a higher value. However, this relationship becomes less pronounced or is inversed in the post-crisis period and concerns both trading and hedging derivatives. For systemically important banks heavily involved in derivatives, market volatility of stock returns is higher and valuations are lower. We notice, however, that derivatives play second fiddle to bank risk and performance. Our findings corroborate the importance of distinction of derivatives by the purpose of use, which becomes less obvious for investors in the post-crisis period. Our results have important policy implications, especially in the light of the recent debate over the necessity of separation of risky banking activities from commercial bank branches (for instance, as proposed in Liikanen report) in an attempt to reduce systemic risk. We emphasise the need for a higher transparency of disclosures regarding hedge accounting and harmonisation of reporting formats across EU.