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An Analysis of Off-Site Supervision of Banks' Profitability, Risk and Capital Adequacy: a portfolio simulation approach applied to brazilian banks

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  • Theodore M. Barnhill
  • Marcos R. Souto
  • Benjamin M. Tabak

Abstract

In most countries, the role of off-site bank supervision involves continuous monitoring of profitability, risk and capital adequacy. The objective of this article is to demonstrate the value of bringing together advanced modeling techniques with data on banks' assets and liabilities and credit worthiness. More specifically, we apply an integrated market and credit risk simulation methodology to a group of six hypothetical banks. We show the capacity of the methodology: (i) to simulate credit transition probabilities of default close to the historical values estimated by the Central Bank of Brazil; and (ii) to simulate asset and equity returns that are unbiased estimators of average historical returns and standard deviations. Our results also indicate that: (i) a sharp reduction in the interest rate spreads of Brazilian banks reduces bank profitability and increases the probability of default; and (ii) most banks have low probability of bankruptcy. Our position is that utilization of forward looking risk evaluation methodologies in databases, such as those developed by the Central Bank of Brazil, has significant potential as an instrument of indirect supervision to identify potential risks before they materialize.

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File URL: http://www.bcb.gov.br/pec/wps/ingl/wps117.pdf
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Bibliographic Info

Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 117.

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Date of creation: Sep 2006
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Handle: RePEc:bcb:wpaper:117

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Web page: http://www.bcb.gov.br/?english

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Cited by:
  1. Barnhill, Theodore M. & Souto, Marcos Rietti, 2008. "Systemic bank risk in Brazil: an assessment of correlated market, credit, sovereign and inter-bank risk in an environment with stochastic volatilities and correlations," Discussion Paper Series 2: Banking and Financial Studies 2008,13, Deutsche Bundesbank, Research Centre.
  2. Vazquez, Francisco & Tabak, Benjamin M. & Souto, Marcos, 2012. "A macro stress test model of credit risk for the Brazilian banking sector," Journal of Financial Stability, Elsevier, vol. 8(2), pages 69-83.

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