Macro-model-based stress testing of Basel II capital requirements
AbstractBasel II framework requires banks to conduct stress tests on their potential future minimum capital requirements and consider ‘at least the effect of mild recession scenarios’. We propose a stress testing framework for minimum capital requirements in which banks’ corporate credit risks are modeled with macroeconomic variables. We can thus define scenarios such as a mild recession and consider the resulting credit risk developments and consequent changes in minimum capital requirements. We also emphasize the importance of stress testing future minimum capital requirements jointly with credit losses. Our illustrative results based on Finnish data underline the importance of such joint modeling. We also find that stress tests based on scenarios envisaged by regulators are not likely to imply binding capital constraints on banks.
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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 17/2008.
Length: 27 pages
Date of creation: 02 Sep 2008
Date of revision:
Basel II; capital requirements; credit risk; loan losses; stress tests;
Find related papers by JEL classification:
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- 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
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-09-20 (All new papers)
- NEP-BAN-2008-09-20 (Banking)
- NEP-FMK-2008-09-20 (Financial Markets)
- NEP-REG-2008-09-20 (Regulation)
- NEP-RMG-2008-09-20 (Risk Management)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Heid, Frank, 2007. "The cyclical effects of the Basel II capital requirements," Journal of Banking & Finance, Elsevier, vol. 31(12), pages 3885-3900, December.
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- Peura, Samu & Jokivuolle, Esa, 2003. "Simulation-based stress testing of banks’ regulatory capital adequacy," Research Discussion Papers 4/2003, Bank of Finland.
- Allen Berger & Robert DeYoung & Mark Flannery & David Lee & Ozde Oztekin, 2008.
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Research Working Paper
RWP 08-01, Federal Reserve Bank of Kansas City.
- Allen Berger & Robert DeYoung & Mark Flannery & David Lee & Özde Öztekin, 2008. "How Do Large Banking Organizations Manage Their Capital Ratios?," Journal of Financial Services Research, Springer, vol. 34(2), pages 123-149, December.
- Virolainen , Kimmo, 2004. "Macro stress testing with a macroeconomic credit risk model for Finland," Research Discussion Papers 18/2004, Bank of Finland.
- Andersen, Henrik, 2011. "Procyclical implications of Basel II: Can the cyclicality of capital requirements be contained?," Journal of Financial Stability, Elsevier, vol. 7(3), pages 138-154, August.
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