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

  • Mike Mariathasan
  • Ouarda Merrouche

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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File URL: http://www.economics.ox.ac.uk/materials/papers/12210/paper621.pdf
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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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  1. Sofiya Avramova & Vanessa Le Leslé, 2012. "Revisiting Risk-Weighted Assets," IMF Working Papers 12/90, International Monetary Fund.
  2. Anat Admati & Martin Hellwig, 2013. "The Bankers' New Clothes: What's Wrong with Banking and What to Do about It," Economics Books, Princeton University Press, edition 1, volume 1, number 9929, April.
  3. Mariathasan, Mike & Merrouche, Ouarda & Werger, Charlotte, 2014. "Bailouts And Moral Hazard: How Implicit Government Guarantees Affect Financial Stability," CEPR Discussion Papers 10311, C.E.P.R. Discussion Papers.
  4. Mitchell A. Petersen, 2009. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 435-480, January.
  5. Perotti, Enrico C & Ratnovski, Lev & Vlahu, Razvan, 2011. "Capital Regulation and Tail Risk," CEPR Discussion Papers 8526, C.E.P.R. Discussion Papers.
  6. Calem, Paul & Rob, Rafael, 1999. "The Impact of Capital-Based Regulation on Bank Risk-Taking," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 317-352, October.
  7. Hau, Harald & Langfield, Sam & Marqués-Ibáñez, David, 2012. "Bank ratings: what determines their quality?," Working Paper Series 1484, European Central Bank.
  8. Keeley, Michael C. & Furlong, Frederick T., 1990. "A reexamination of mean-variance analysis of bank capital regulation," Journal of Banking & Finance, Elsevier, vol. 14(1), pages 69-84, March.
  9. Blum, Jürg M., 2008. "Why 'Basel II' may need a leverage ratio restriction," Journal of Banking & Finance, Elsevier, vol. 32(8), pages 1699-1707, August.
  10. Ouarda Merrouche & Enrica Detragiache & Asli Demirgüç-Kunt, 2010. "Bank Capital; Lessons From the Financial Crisis," IMF Working Papers 10/286, International Monetary Fund.
  11. Martin Hellwig, 2010. "Capital Regulation after the Crisis: Business as Usual?," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, vol. 8(2), pages 40-46, 07.
  12. Luc Laeven & Harry Huizinga, 2009. "Accounting Discretion of Banks During a Financial Crisis," IMF Working Papers 09/207, International Monetary Fund.
  13. Acharya, Viral V & Schnabl, Philipp & Suarez, Gustavo, 2012. "Securitization Without Risk Transfer," CEPR Discussion Papers 8769, C.E.P.R. Discussion Papers.
  14. Huizinga, Harry & Laeven, Luc, 2012. "Bank valuation and accounting discretion during a financial crisis," Journal of Financial Economics, Elsevier, vol. 106(3), pages 614-634.
  15. repec:dgr:uvatin:2011039 is not listed on IDEAS
  16. Furlong, Frederick T. & Keeley, Michael C., 1989. "Capital regulation and bank risk-taking: A note," Journal of Banking & Finance, Elsevier, vol. 13(6), pages 883-891, December.
  17. repec:dgr:uvatin:20110039 is not listed on IDEAS
  18. Sandra E. Black & Philip E. Strahan, 2002. "Entrepreneurship and Bank Credit Availability," Journal of Finance, American Finance Association, vol. 57(6), pages 2807-2833, December.
  19. 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.
  20. James J. Heckman, 1976. "The Common Structure of Statistical Models of Truncation, Sample Selection and Limited Dependent Variables and a Simple Estimator for Such Models," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 5, number 4, pages 475-492 National Bureau of Economic Research, Inc.
  21. 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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