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Integrating Stress Tests within the Basel III Capital Framework: A Macroprudentially Coherent Approach

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  • Pierluigi Bologna
  • Anatoli Segura

Abstract

In the post-crisis era, banks’ capital adequacy is established by the Basel III capital standards and, in many jurisdictions, also by supervisory stress tests. In this article, we first describe the ways in which supervisory stress tests can supplement the risk-based capital framework of Basel III and how this could be codified with a stress test buffer. We then argue that in order to ensure coherence with the macroprudential objectives of Basel III, the severity of supervisory stress tests should be procyclical. In addition, to increase the transparency and predictability of the overall capital framework, severity choices should follow a constrained discretion approach based on a simple rule. Finally, we analyse supervisory stress testing practices across some jurisdictions and find that while in the USA and the UK they take into account some of our proposals, including most notably the need for procyclical severity, this is not the case in the euro area.

Suggested Citation

  • Pierluigi Bologna & Anatoli Segura, 2017. "Integrating Stress Tests within the Basel III Capital Framework: A Macroprudentially Coherent Approach," Journal of Financial Regulation, Oxford University Press, vol. 3(2), pages 159-186.
  • Handle: RePEc:oup:refreg:v:3:y:2017:i:2:p:159-186.
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    More about this item

    Keywords

    stress test; capital regulation; macroprudential policy; procyclicality;

    JEL classification:

    • 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

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