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Is Current Capital Regulation Based on Conservative Risk Assessment?

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Author Info

  • Thomas Breuer

    ()
    (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.)

  • Martin Jandacka

    ()
    (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.)

  • Klaus Rheinberger

    ()
    (Research Centre PPE, Fachhochschule Vorarlberg, Hochschulstr. 1, A-6850 Dornbirn, Austria.)

  • Martin Summer

    ()
    (Oesterreichische Nationalbank, Economic Studies Division)

Abstract

We criticize the popular view that separately calculating regulatory capital for market and credit risk yields a conservative aggregate risk assessment. We show that this view depends on a flawed intuition about diversification effects that arise between subportfolios. If a bank’s portfolio cannot be neatly divided into two subportfolios along the lines of market and credit risk, simply adding up the respective results may cause the true portfolio risk to be underestimated. Using the example of foreign currency loan portfolios, we show that this underestimation can be quantitatively significant.

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File URL: http://www.oenb.at/dms/oenb/Publikationen/Finanzmarkt/Financial-Stability-Report/2008/Financial-Stability-Report-15/chapters/fsr_15_special_topics_03_tcm16-87341.pdf
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Bibliographic Info

Article provided by Oesterreichische Nationalbank (Austrian Central Bank) in its journal Financial Stability Report.

Volume (Year): (2008)
Issue (Month): 15 ()
Pages: 112-118

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Handle: RePEc:onb:oenbfs:y:2008:i:15:b:3

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Related research

Keywords: Integrated analysis of market and credit risk; risk management; foreign currency loans; banking regulation.;

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