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The Manipulation of Basel Risk-Weights. Evidence from 2007-10

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  • Mike Mariathasan
  • Ouarda Merrouche

Abstract

In this paper, we analyse a novel panel data set to compare the relevance of alternative measures of capitalisation for bank failure during the 2007-10 crisis, and to search for evidence of manipulated Basel risk-weights.� Compared with the unweighted leverage ratio, we find the risk-weighted asset ratio to be a superior predictor of bank failure when banks operate under the Basel II regime, provided that the risk of a crisis is low.� When the risk of a crisis is high, the unweighted leverage ratio is the more reliable predictor.� However, when banks do not operate under Basel II rules, both ratios perform comparably, independent of the risk of a crisis.� Furthermore, we find a strong decline in the risk-weighted asset ratio leading up to the crisis.� Several empirical findings indicate that this decline is driven by the strategic use of internal risk models under the Basel II advanced approaches.� Evidence of manipulation is stronger�in less competitive banking systems, in banks with low initial levels of Tier 1 capital and in banks that adopted Basel II rules early.� We find tangible common equity and Tier 1 ratios to be better predictors of bank distress than broader measures of capital, and identify market-based measures of capitalisation as poor indicators.� We find no relationship between the probability of a bank being selected into a public recapitalisation plan and regulatory measures of capital.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 621.

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Date of creation: 13 Sep 2012
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Handle: RePEc:oxf:wpaper:621

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Keywords: Banks; Basel risk-weights; Capital; Regulation;

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References

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  1. Berger, Allen N. & Bouwman, Christa H.S., 2013. "How does capital affect bank performance during financial crises?," Journal of Financial Economics, Elsevier, vol. 109(1), pages 146-176.
  2. Acharya, Viral V & Schnabl, Philipp & Suarez, Gustavo, 2012. "Securitization Without Risk Transfer," CEPR Discussion Papers 8769, C.E.P.R. Discussion Papers.
  3. Asli Demirguc‐Kunt & Enrica Detragiache & Ouarda Merrouche, 2013. "Bank Capital: Lessons from the Financial Crisis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 45(6), pages 1147-1164, 09.
  4. Enrico Perotti & Lev Ratnovski & Razvan Vlahu, 2011. "Capital Regulation and Tail Risk," Tinbergen Institute Discussion Papers 11-039/2/DSF14, Tinbergen Institute, revised 31 Mar 2011.
  5. Hau, Harald & Langfield, Sam & Marqués-Ibáñez, David, 2012. "Bank ratings: what determines their quality?," Working Paper Series 1484, European Central Bank.
  6. Mike Mariathasan & Ouarda Merrouche, 2012. "Recapitalization, credit and liquidity," Economic Policy, CEPR & CES & MSH, vol. 27(72), pages 603-646, October.
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Cited by:
  1. Bulow, Jeremy & Klemperer, Paul, 2013. "Market-Based Bank Capital Regulation," Research Papers 2132, Stanford University, Graduate School of Business.
  2. Tümer Kapan & Camelia Minoiu, 2013. "Balance Sheet Strength and Bank Lending During the Global Financial Crisis," IMF Working Papers 13/102, International Monetary Fund.

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