Risk Measures: Robustness, Elicitability, and Backtesting

Risk measures are used not only for financial institutions’ internal risk management but also for external regulation (e.g., in the Basel Accord for calculating the regulatory capital requirements for financial institutions). Though fundamental in risk management, how to select a good risk measure is a controversial issue. We review the literature on risk measures, particularly on issues such as subadditivity, robustness, elicitability, and backtesting. We also aim to clarify some misconceptions and confusions in the literature. In particular, we argue that, despite lacking some mathematical convenience, the median shortfall—that is, the median of the tail loss distribution—is a better option than the expected shortfall for setting the Basel Accords capital requirements due to statistical and economic considerations such as capturing tail risk, robustness, elicitability, backtesting, and surplus invariance. Expected final online publication date for the Annual Review of Statistics, Volume 9 is March 2022. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.

“Sub-debt trap”: a real effect of an ill-design adoption of basel accord in the Bangladeshi banking industry

Purpose The purpose of this paper is to investigate the impact of basel accord on the Bangladeshi bank performance including Islamic banks and the role of subordinated debt (sub-debt) as basel regulatory capital (BRC). Design/methodology/approach The authors conducted the empirical investigation by adopting a quantitative approach and using the secondary data available in the annual reports of the sample banks between 2009 and 2018. This paper develops an econometric model to compare and analyze the regression result under two states of capital-to-risk adjusted assets ratio (CRAR) with sub-debt and CRAR without sub-debt. This paper analyzes the impact of sub-debt in the largest Islamic bank for the year 2007 as a case study for endorsing the findings. Findings This paper finds that CRAR has positive alignments with return on equity (ROE) and cash dividend when sub-debt is considered as Tier 2 capital. This paper observes that the huge bad loan write-off supports to downsize the asset size thus temporarily enhance the return on assets (ROA). In a nutshell, sub-debt gives banks an ill incentive to disburse steady cash dividends instead of injecting genuine equity capital, encouraging them to take more credit risk. In fact, more private commercial banks (PCBs) issued huge sub-debts between 2009 and 2018 under a unique arrangement, which the authors termed as the “sub-debt trap.” Research limitations/implications This paper draws policy implications for the banking regulator to identify and rectify a systemic problem of the “sub-debt trap” which hinders the regulatory purpose from the implementation of basel accord II and III. A limitation of this study is the authors shed analytical light on Bangladeshi banks, i.e. it a single country analysis which may not be generalized to other developing countries except matching with a similar context. Originality/value The paper contributes to accumulating empirical studies on the effectiveness of basel accord implementation in developing countries. In most of the developing countries, where institutional loopholes are a major concern, the research provides evidence that how weak institutional settings are largely responsible for harvesting the potential benefit from micro-prudential regulation such as the basel accord. To shed analytical light on developing country context, the study document that sub-debt has been instrumentalized to maintain minimum capital ratio and banks managers tends more focus on improving ROE instead of ROA. The findings of the study are supportive to other developing countries where sub-debt considered as BRC and issued through private placement. To the best of the authors’ knowledge, it is the first attempt to cast doubt on the impact of sub-debt as a BRC, given the uniqueness of the Bangladeshi banking industry, on the PCBs including Islamic banks.

Basel violations, volatility model variants and value at risk: Optimization of performance deviations in banks

Basel penalties originate from VaR violations where a bank may end up either holding more capital or will risk to be reverted to standardized approach. Regulatory capital charge can have a huge impact on banks’ profitability which depends on the estimation of VaR thresholds which is evaluated by the approaches like hypothesis tests, back-testing procedures and Basel Accord regulatory calculations for penalty zones are used. A multi-criteria performance measure has been introduced in this study in order to select the optimal internal model based on performance evaluation techniques which could possibly help in reduction in the VaR violations and thus may leave more capital with banks.

PROSPECTS FOR ENSURING THE FINANCIAL SECURITY AND STABILITY OF THE BANKING SYSTEM OF AZERBAIJAN USING THE PRINCIPLES OF THE BASEL ACCORD (BASEL II)

The article discusses some aspects of the application of the developed Basel II principles to improve measures to ensure financial stability and security of the banking system of Azerbaijan. The advantages of using this agreement and the effectiveness of its application within the banking system of Azerbaijan are considered.

Regulatory Estimates for Defaulted Exposures: A Case Study of Spanish Mortgages

The capital requirements derived from the Basel Accord were issued with the purpose of deploying a transnational regulatory framework. Further regulatory developments on risk measurement is included across several documents published both by the European Banking Authority and the European Central Bank. Among others, the referred additional documentation focused on the models’ estimation and calibration for credit risk measurement purposes, especially the Advanced Internal-Ratings Based models, which may be estimated both for non-defaulted and defaulted assets. A concrete proposal of the referred defaulted exposures models, namely the Expected Loss Best Estimate (ELBE) and the Loss Given Default (LGD) in-default, is presented. The proposed methodology is eventually calibrated on the basis of data from the mortgage’s portfolios of the six largest financial institutions in Spain. The outcome allows for a comparison of the risk profile particularities attached to each of the referred portfolios. Eventually, the economic sense of the results is analyzed.

The Impact of BASEL Accords on the Management of Vietnamese Commercial Banks

This paper is an attempt to empirically examine the impact of Basel Accord regulatory guidelines on the risk-based capital adequacy regulation and bank risk management of Vietnamese commercial banks. Our research aims to assess how Vietnamese commercial banks manage their capital ratio and bank risk under the latest Basel Accord capital adequacy ratio requirements. Building on previous studies, this research uses a simultaneous equation modeling (SiEM) with three-stage least squares regression (3SLS) to analyze the endogenous relationship between risk-based capital adequacy standards and bank risk management. A year dummy variable (dy2013) is included in the model to take account of changes in the regulation of the Vietnamese banking system. Furthermore, we add a value-at-risk variable developed by as an independent variable into equations of the empirical models. The results reveal a significant impact of Basel capital adequacy regulatory pressure on the risk-based capital adequacy standards and bank risk management of Vietnamese commercial banks. Moreover, banks under the latest Basel capital adequacy regulations are induced to reduce risks and increase banks’ financial performance.

A Critique of Bangladeshi Adoption of Basel Type Capital Regulation: An Institutional View

International concern on bank capital and minimum capital adequacy was first raised in 1980, in the G-10 countries governors meeting at the Bank for International Settlements (BIS) to respond to a series of bank failures and financial instability observed in Western developed economies. Later, the Basel Committee on Banking Supervision (BCBS) of the BIS proposed the Basel accord I, II and III in 1988, 2004 and 2010, respectively. Bangladesh Bank (BB) has introduced the ‘capital to risk weighted assets’-based approach for assessing the capital adequacy of banks in 1996 and later formally introduced the Basel framework in the early 2000s for its regulated banks. However, during Basel accord II and III implementation period (2009-2018), the banking industry accumulated huge non-performing loans which eroded its profitability. This creates a skepticism regarding any loopholes within the institutions. This paper argues that the naïve and excess reliance on External Credit Assessment Institutions (ECAIs’) credit rating in the process of adopting the Basel-type capital adequacy amounted to a risky strategy for the Bangladeshi banking industry in a sense that ECAIs allocate less efforts on accumulation of credit risk screening skills. We also document that the huge transaction cost and high coupon rate embedded within the debt instrument like the subordinated debt (sub-debt) issued by the regulated banks as Tier 2 capital might shrink the bank’s profitability and its contribution to the national exchequer. Little in the existing literature has been addressed to investigate the adoption of Basel regulations in Bangladesh from the institutional lens. This paper critically reviewed the Bangladeshi ECAIs regulations and sub-debt regulations to fill this research gap.