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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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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
Date of revision:
Handle: RePEc:oxf:wpaper:621
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  1. Enrico Camillo Perotti & Lev Ratnovski & Razvan Vlahu, 2011. "Capital Regulation and Tail Risk," IMF Working Papers 11/188, International Monetary Fund.
  2. Harald Hau & Sam Langfield & David Marques-Ibanez, 2013. "Bank ratings: what determines their quality?," Economic Policy, CEPR;CES;MSH, vol. 28(74), pages 289-333, 04.
  3. Huizinga, H.P. & Laeven, L., 2009. "Accounting Discretion of Banks During a Financial Crisis," Discussion Paper 2009-58, Tilburg University, Center for Economic Research.
  4. Acharya, Viral V. & Schnabl, Philipp & Suarez, Gustavo, 2013. "Securitization without risk transfer," Journal of Financial Economics, Elsevier, vol. 107(3), pages 515-536.
  5. Mike Mariathasan & Ouarda Merrouche, 2012. "Recapitalization, credit and liquidity," Economic Policy, CEPR;CES;MSH, vol. 27(72), pages 603-646, October.
  6. Ouarda Merrouche & Enrica Detragiache & Asli Demirgüç-Kunt, 2010. "Bank Capital: Lessons From the Financial Crisis," IMF Working Papers 10/286, International Monetary Fund.
  7. 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.
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