On the Risk Capital Framework of Financial Institutions
AbstractIn this paper, we consider the risk capital framework adopted by financial institutions. Specifically, we review the recent literature on this issue, and clarify the economic assumptions behind this framework. Based on these observations, we then develop a simple model for analyzing the economic implications of this framework. The main implications are as follows. First, risk capital allocations are theoretically unnecessary without deadweight costs for raising capital, which are not usually assumed in the business practices of financial institutions. Second, the risk-adjusted rate of return is redundant as it provides no additional information beyond the net present value. Third, risk capital allocation is intrinsically difficult because it is hard to incorporate the correlations among asset returns.
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Bibliographic InfoArticle provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.
Volume (Year): 21 (2003)
Issue (Month): 3 (October)
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Find related papers by JEL classification:
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
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