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Prudential filters, portfolio composition at fair value and capital ratios in European banks

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  • Argimón, Isabel
  • Dietsch, Michel
  • Estrada, Ángel

Abstract

European banks hold 10% of their total assets in portfolios that give rise to unrealised gains and losses which, under Basel III, may no longer be removed from banks’ regulatory capital. Using a sample of European banks, and taking advantage of the different regulatory treatment afforded, under Basel II, to such gains and losses across jurisdictions and instruments and over time, we find evidence that: a) the inclusion of unrealised gains and losses in regulatory capital ratios increases their volatility; b) the total or partial inclusion in regulatory capital of unrealised gains and losses on fixed-income securities reduces the volume of debt at fair value, thus potentially affecting the demand for liquid long-term securities (most of which are currently government bonds); and c) the higher the proportion of gains on debt instruments allowed in regulatory capital, the higher the regulatory Tier 1 capital ratio, thus affecting banks’ capital buffer strategy.

Suggested Citation

  • Argimón, Isabel & Dietsch, Michel & Estrada, Ángel, 2018. "Prudential filters, portfolio composition at fair value and capital ratios in European banks," Journal of Financial Stability, Elsevier, vol. 39(C), pages 187-208.
    • Handle: RePEc:eee:finsta:v:39:y:2018:i:c:p:187-208
    DOI: 10.1016/j.jfs.2017.03.004
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    1. Brei, Michael & Gambacorta, Leonardo & Lucchetta, Marcella & Parigi, Bruno Maria, 2023. "How effective are bad bank resolutions? New evidence from Europe," Journal of Financial Stability, Elsevier, vol. 67(C).

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    More about this item

    Keywords

    Prudential regulation; Regulatory capital; Fair value accounting; Prudential filters;
    All these keywords.

    JEL classification:

    • 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
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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