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Prudential filters, portfolio composition and capital ratios in European banks

Listed author(s):
  • I. Argimon
  • M. Dietsch
  • A. Estrada

European banks hold 10% of their total assets in portfolios that give rise to unrealised gains and losses which under Basel III will no longer be allowed to be excluded from banks’ regulatory capital. Using a sample of European banks, and taking advantage of the different regulatory treatments that are allowed, under Basel II, to account for such gains and losses among jurisdictions and instruments and over time, we find evidence that: a) the inclusion of unrealised gains and losses in capital ratios increases their volatility; b) the partial inclusion of unrealised gains and total inclusion of losses on fixed-income securities in regulatory capital, compared with the complete exclusion of both (or “neutralization”), reduces the volume of securities categorised as Available For Sale (AFS), thus potentially affecting liquidity management and demand for bonds (most of which are currently government bonds); and c) the higher the partial inclusion of gains from debt instruments, the lower the holdings of such instruments in the AFS category and the higher the regulatory Tier 1 capital ratio, thus affecting banks’ capital buffer strategy. We do not find evidence that the absence of neutralisation would impact capital ratios.

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File URL: https://acpr.banque-france.fr/fileadmin/user_upload/acp/publications/Debats_economiques_et_financiers/20160818-Prudential-filters-portfolio-composition-and-capital-ratios-in-European-banks.pdf
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Paper provided by Banque de France in its series Débats économiques et financiers with number 22.

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Length: 39 pages
Date of creation: 2016
Handle: RePEc:bfr:decfin:22
Contact details of provider: Postal:
Banque de France 31 Rue Croix des Petits Champs LABOLOG - 49-1404 75049 PARIS

Web page: http://www.banque-france.fr/

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  1. Allen, Franklin & Carletti, Elena, 2008. "Mark-to-market accounting and liquidity pricing," Journal of Accounting and Economics, Elsevier, vol. 45(2-3), pages 358-378, August.
  2. Justin Chircop & Zoltán Novotny-Farkas, 2014. "The economic consequences of including fair value adjustments to shareholders’ equity in regulatory capital calculations," IEHAS Discussion Papers 1426, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
  3. Borio, Claudio & Tsatsaronis, Kostas, 2004. "Accounting and prudential regulation: from uncomfortable bedfellows to perfect partners?," Journal of Financial Stability, Elsevier, vol. 1(1), pages 111-135, September.
  4. Barth, Mary E. & Gomez-Biscarri, Javier & Kasznik, Ron & Lopez-Espinosa, German, 2014. "Bank Earnings and Regulatory Capital Management Using Available for Sale Securities," Research Papers 3047, Stanford University, Graduate School of Business.
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