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Is Current Capital Regulation Based on Conservative Risk Assessment?

Author

Listed:
  • 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.

Suggested Citation

  • Thomas Breuer & Martin Jandacka & Klaus Rheinberger & Martin Summer, 2008. "Is Current Capital Regulation Based on Conservative Risk Assessment?," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 15, pages 112-118.
  • Handle: RePEc:onb:oenbfs:y:2008:i:15:b:3
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    References listed on IDEAS

    as
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    More about this item

    Keywords

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

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General

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