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Banks are exposed to climate risks through stranded assets. This risk can be substantial in the banking sector, as it can spawn systemic risk. After the Great Recession, macro-prudential instruments effectively addressed systemic risk. However, climatic risks raise the research question of how feasible it is to address them by adopting macro-prudential instruments. The researchers, therefore, investigate how banks can respond to the risk posed by stranded assets through the framework of using macro-prudential instruments. A semi-systematic review of the related literature is carried out based on the researchers' aim to evaluate theory evidence in the effectiveness of macro-prudential instruments in addressing climate-related risks. The adaptability of macro-prudential instruments to address climatic risks and, by implication, systemic risk is demonstrated in the findings. The researchers develop a framework constituting climate transparency disclosures, climate capital requirement ratio, climate capital conservation, carbon countercyclical buffer and macro-prudential climate stress tests to mitigate the effects of climate risks in banking. [ABSTRACT FROM AUTHOR]

Recent literature suggests that regulatory risk measures do not adequately capture the actual economic risk of bank portfolios. We shed new light on this issue by analyzing both regulatory and accounting standards, i.e. capital requirements and loan loss provisions. Examining a sample of large European banks for the years 2002–2015, we show that regulatory risk sensitivity, i.e. the response of Basel risk weights to asset volatility as our measure of a bank's asset portfolio risk, is substantially higher than what has been shown so far in the literature. Despite the occasionally bad reputation that risk weights have, we provide new evidence that they are adequately calibrated for banks with low or medium levels of risk. For crisis periods and for high-risk banks, however, risk weights still do not adequately reflect the actual portfolio risk. This results in insufficient capital, even with the stricter Basel III minimum capital requirements. Regarding loan loss provisions, we establish a theoretical link between expected losses and asset volatility. We document a strong empirical association, which fits well to the theoretical model. Overall, we find no indication that the risk sensitivity of loan loss provisions has been insufficient, at least since the financial crisis. [ABSTRACT FROM AUTHOR]

The capital regulation reform package (CRR2) proposed for the EU banking sector introduces a minimum leverage ratio as a (non-risk-weighted) prudential backstop. In this paper, we use Czech bank-level data to explore the implications of introducing a leverage ratio into the capital regulatory framework. Specifically, we create an artificial 'laboratory' environment where we study the relationship between the two regulatory tools and selected bank-specific variables. We identify channels through which the capital and leverage ratios might be affected and test the functionality of those channels. Our results confirm that the capital and leverage ratios complement each other and that the leverage ratio is far less procyclical than the capital ratio. We also demonstrate an over-the-cycle functionality of our proposed channels of interaction between the capital and leverage ratios. We show that the leverage ratio (or similar microprudential backstops, such as an output floor) could be an important tool for maintaining resilience, especially for banking sectors with a high share of banks using the internal rating-based approach to risk weight setting. [ABSTRACT FROM AUTHOR]

The article uses a bank’s credit data to study the impact of the Basel IV regulations on risk weight density (RWD). The analysis of the simulated data shows mixed results, as the improvement of risk weight heterogeneity is restricted to optimistically valued portfolios. Conservatively valued portfolios are likely to be confronted with an RWD decrease. However, within these portfolios, risk weight heterogeneity usually does not play an important role. Out of all the analysed Basel IV rules, the output floor clearly has the biggest influence on risk weight density, while the effect of the input floors is very limited within optimistically valued portfolios and is even eliminated by the removal of the scaling factor within conservatively valued portfolios. The change in RWD will also lead to a concurrent change in risk-weighted assets and therefore also in the level of eligible capital. The findings within the retail portfolio confirm those of the EBA study, which already suggested that Basel IV and especially the output floor will lead to a significant increase of risk capital (European Banking Authority, 2018).

In line with the norms suggested by the Basel Committee on Banking Supervision (BCBS) of the Bank for International Settlements (BIS), Reserve Bank of India (RBI) has issued capital adequacy guidelines for Indian Banks. The latest guidelines effective from April, 2013, known as Basel III, have provided for capital components which carry more stringent conditions, relative to earlier ones (Basel II), including cancellation of dividend or interest and writing off/ conversion of hybrid or debt instruments into equity on occurrence of specified trigger points resulting in loss allocation. The primary focus in Basel III is on common equity capital. However, the capital components qualifying for the purpose of capital adequacy also include preference capital both in Tier 1 and Tier 2 capital subject to satisfaction of conditions prescribed by RBI. The new capital adequacy framework is to be implemented in phases with full implementation is to be achieved by March, 2019. On full implementation, total eligible capital with reference to risk assessed assets is required to be 9% with common equity Tier 1 ratio at 5.5%, Tier 1 ratio at 7% and Tier 2 capital ratio at 2%. The paper examines the role played by preference capital in the composition of capital adequacy of Indian banks. [ABSTRACT FROM AUTHOR]

While many efforts have been made recently by the EU to prevent spill-overs of banking crises to the fiscal domain, potential contagion from sovereigns to banks is yet to be addressed by public policy. This study provides a quantitative impact assessment of a potential tightening in the banking regulatory framework of sovereign exposures within the EU, either in the form of large exposure limits or non-zero risk weights. Such a shift in regulation would require a large portfolio rebalancing for the banking sector in the euro area, and would lead to large excess supply on government bond markets, as well as leading to potentially sizable impact on long-term yields. The impact on banks and bond markets in the non-euro area EU economies are also found to be sizable, while in these countries the adjustment would not be supported by common risk-sharing mechanisms. [ABSTRACT FROM AUTHOR]

We empirically assess the sensitivity of Basel risk weights to bank portfolio risk and the business cycle. With our econometric model, we distinguish between cross-sectional risk sensitivity and longitudinal risk sensitivity (cyclicality) of the regulatory standard. Employing a comprehensive data set covering 200 large banks from 28 countries, we find that actual risk weights are fairly insensitive to the business cycle. There is no evidence that Basel II has significantly increased cyclicality. Furthermore, cross-sectional risk sensitivity of regulatory risk weights to a market measure of bank portfolio risk is low. We further assess the adequacy of the capital standard's risk sensitivity based on a Merton-style model of bank risk and bank default. Judged upon the Basel Committee's self-established goal of maintaining bank default rates below 0.1 %, our results suggest that risk weights and minimum capital requirements are ill-calibrated, even under the stricter Basel III rules. [ABSTRACT FROM AUTHOR]

Capital regulation is critical to address distortions and externalities from intense conflicts of interest in banking and from the failure of markets to counter incentives for recklessness. The approaches to capital regulation in Basel III and related proposals are based on flawed analyses of the relevant tradeoffs. The flaws in the regulations include dangerously low equity levels, a complex and problematic system of risk weights that exacerbates systemic risk and adds distortions, and unnecessary reliance on poor equity substitutes. The underlying problem is a breakdown of governance and lack of accountability to the public throughout the system, including policymakers and economists. [ABSTRACT FROM AUTHOR]

Purpose – This paper aims to examine the impact of macroprudential policies (MPPs) on credit growth. Towards this end, the author uses quarterly data on Indian commercial banks for the period 2002:1 to 2012:1 that subsume the imposition of MPPs. Design/methodology/approach – The analysis uses the dynamic panel data (DPD) methodology to test the relevant hypotheses regarding the interlinkage between credit growth, bank ownership and MPPs. The DPD methodology has the advantage of being able to address the endogeneity between credit growth and macroprudential regulation. Findings – The results appear to suggest that MPPs targeted on provisions are relatively more effective in limiting credit expansion. When considered in conjunction with bank ownership, they appear to have much more force in moderating the severity of the credit cycle. Research limitations/implications – The lack of an extensive database on the relevant variables might hinder the robustness of the results. It is possible that MPPs are effective in curbing loan extension to targeted sectors, which cannot be adequately examined using aggregate loan data. Practical implications – The role and usefulness of MPPs in limiting the build-up of risk has been widely discussed in recent times. Judged from that standpoint, the paper contributes to this literature by examining the issue for a leading emerging economy. Originality/value – To the best of the author’s knowledge, this is one of the earliest studies to examine this issue in a systematic manner for India. [ABSTRACT FROM AUTHOR]

The article examines the impact of macroprudential policies on bank credit growth. Towards this end, we develop a model of bank behaviour which examines the possible impact of such policies. The testable propositions of the model are empirically examined using a natural experiment for India. The results appear to suggest that macroprudential policies interact with bank ownership to moderate the severity of the credit cycle. [ABSTRACT FROM PUBLISHER]

The Basle Supervisors' Committee (BIS) capital adequacy proposals of July 1988 called on the G10 supervisory authorities to ensure that all internationally active banks falling under their jurisdiction observe a minimum 8 per cent risk-asset ratio by the end of 1992. This article presents a critique, not of the general principles of Basle, but of the details that are seen to weaken the value of the agreement. The risk-asset ratio and the derivation of risk weights are considered. JEL: G21, G32, G28

Using supervisory data for U.S. banks, we evaluate the alignment of Basel II/III AIRB (advanced internal ratings based) risk estimates with portfolio risk. We use loan performance as a direct measure of portfolio risk as well as less direct market-based measures. Our results document that AIRB risk weights are highly correlated with loan performance and that, in contrast, Basel I risk weights are not. We find that capital requirements under the AIRB approach are higher than those under Basel I especially for portfolios recently under stress such as mortgages and some sovereign exposures. The alignment of Basel risk estimates with market-based risk indicators is less robust, although the association is nevertheless stronger under the AIRB approach. Our results support the view that internally generated risk weights are determined mostly by portfolio risk and, as a result, are substantially more risk sensitive than the fixed asset class based risk weights of Basel I. [ABSTRACT FROM AUTHOR]

In this study, we analyze why commercial banks failed during the recent financial crisis. We find that traditional proxies for the CAMELS components, as well as measures of commercial real estate investments, do an excellent job in explaining the failures of banks that were closed during 2009, just as they did in the previous banking crisis of 1985-1992. Surprisingly, we do not find that residential mortgage-backed securities played a significant role in determining which banks failed and which banks survived. Our results offer support for the CAMELS approach to judging the safety and soundness of commercial banks, but call, into serious question the current system of regulatory risk weights and concentration limits on commercial real estate loans. [ABSTRACT FROM AUTHOR]

The Basel Committee on Banking Supervision is proposing to introduce, in 2006, new risk-based requirements for internationally active (and other significant) banks. These will replace the relatively risk-invariant requirements in the current Accord. The new requirements for the largest bank will be based on bank ratings of the probability of default of the borrowers. There is evidence that the choice of loan ratings which are conditional on the point in the economic cycle could lead to sharp increases in capital requirements in recessions. This makes the question of which rating schemes banks will use very important. The paper uses a general equilibrium model of the financial system to explore whether banks would choose to use a countercyclical, procyclical or neutral rating scheme. The results indicate that banks would not choose a stable rating approach, which has important policy implications for the design of the Accord. It makes it important that banks are given incentives to adopt more stable rating schemes. This consideration has been reflected in the Committee's latest proposals, in October 2002. [ABSTRACT FROM AUTHOR]