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Risk Measurement, Risk Management and Capital Adequacy in Financial Conglomerates

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  • Andrew Kuritzkes
  • Til Schuermann
  • Scott M. Weiner

Abstract

Is there something special, with respect to risk and capital, about a financial conglomerate that combines banking, insurance and potentially other financial and non-financial activities? To what degree is the risk of the whole less than the sum of its parts? This paper seeks to address these questions by evaluating the risk profile of a typical banking-insurance conglomerate, highlighting the key analytical issues relating to risk aggregation, and raising policy considerations. Risk aggregation is the main analytical hurdle to arriving at a composite risk picture. We propose a "building block" approach that aggregates risk at three successive levels in an organization, (corresponding to the levels at which risk is typically managed). Empirically, diversification effects are greatest within a single risk factor (Level I), decrease at the business line level (Level II), and are smallest across business lines (Level III). Our estimates suggest that the incremental diversification benefits achievable at Level III are modest, around 5-10% reduction in capital requirements, depending on business mix.

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File URL: http://fic.wharton.upenn.edu/fic/KSW%20Financial%20Conglomerates%201.3.pdf
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Bibliographic Info

Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 03-02.

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Date of creation: Nov 2002
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Handle: RePEc:wop:pennin:03-02

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Keywords: Economic capital; financial regulation; risk aggregation;

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References

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Citations

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Cited by:
  1. Benito Arruñada, 2011. "Mandatory accounting disclosure by small private companies," European Journal of Law and Economics, Springer, vol. 32(3), pages 377-413, December.
  2. Carey, Mark & Stulz, Rene M., 2005. "The Risks of Financial Institutions," Working Paper Series 2005-13, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  3. Brack, Estelle, 2009. "États-Unis,“soupe primitive” de la crise financière
    [The United-States : "primitive soup" of the financial turmoil]    ," MPRA Paper 23480, University Library of Munich, Germany.
  4. Sanjiv Das, 2007. "Basel II: Correlation Related Issues," Journal of Financial Services Research, Springer, vol. 32(1), pages 17-38, October.
  5. Piergiorgio Alessandri & Mathias Drehmann, 2009. "An economic capital model integrating credit and interest rate risk in the banking book," Working Paper Series 1041, European Central Bank.
  6. Stephanou, Constantinos, 2005. "Supervision of financial conglomerates : the case of Chile," Policy Research Working Paper Series 3553, The World Bank.
  7. Mark Carey & Rene M. Stulz, 2007. "Introduction to "The Risks of Financial Institutions"," NBER Chapters, in: The Risks of Financial Institutions, pages 1-26 National Bureau of Economic Research, Inc.
  8. Andrew Kuritzkes & Til Schuermann & Scott Weiner, 2005. "Deposit Insurance and Risk Management of the U.S. Banking System: What is the Loss Distribution Faced by the FDIC?," Journal of Financial Services Research, Springer, vol. 27(3), pages 217-242, September.
  9. Donato Masciandaro, 2006. "E Pluribus Unum? Authorities' Design in Financial Supervision: Trends and Determinants," Open Economies Review, Springer, vol. 17(1), pages 73-102, January.

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