Thesis-2006-Eksi.pdf (20.01 MB)
The impact of the market risk of capital regulations on bank activities
thesis
posted on 2011-01-26, 09:25 authored by Emrah EksiBanking has a unique role in the well-being of an economy. This role makes banks
one of the most heavily regulated and supervised industries. In order to strengthen
the soundness and stability of banking systems, regulators require banks to hold
adequate capital. While credit risk was the only risk that was covered by the original
Basle Accord, with the 1996 amendment, banks have also been required to assign
capital for their market risk starting from 1998.
In this research, the impact of the market risk capital regulations on bank capital
levels and derivative activities is investigated. In addition, this study also evaluates
the impact of using different approaches that are allowed to be used while calculating
the required market risk capital, as well as the accuracy of VaR models.
The implementation of the market risk capital regulations can influence banks either
by increasing their capital or by decreasing their trading activities and in particular
trading derivative activities. The literature review concerning capital regulations
illustrates that in particular the impact of these regulations on bank capital levels and
derivative activities is an issue that has not yet been explored. In order to fill this gap,
the changes in capital and derivatives usage ratios are modelled by using a partial
adjustment framework. The main results of this analysis suggest that the
implementation of the market risk capital regulations has a significant and positive
impact on the risk-based capital ratios of BHCs. However, the results do not indicate
any impact of these regulations on derivative activities. The empirical findings also demonstrate that there is no significant relationship between capital and derivatives. The market risk capital regulations allow the use of either a standardised approach or the VaR methodologies to determine the required capital amounts to cover market
risk. In order to evaluate these approaches, firstly differences on bank VaR practices
are investigated by employing a documentary analysis. The documentary analysis is
conducted to demonstrate the differences in bank VaR practices by comparing the
VaR models of 25 international banks. The survey results demonstrate that there, is
no industry consensus on the methodology for calculating VaR. This analysis also
indicates that the assumptions in estimating VaR models vary considerably among
financial institutions. Therefore, it is very difficult for financial market participants to
make comparisons across institutions by considering single VaR values.
Secondly, the required capital amounts are calculated for two hypothetical foreign
exchange portfolios by using both the standardised and three different VaR
methodologies, and then these capital amounts are compared. These simulations are
conducted to understand to what extent the market risk capital regulations
approaches produce different outcomes on the capital levels. The results indicate that
the VaR estimates are dependent upon the VaR methodology.
Thirdly, three backtesting methodologies are applied to the VaR models. The results
indicate that a VaR model that provides accurate estimates for a specific portfolio
could fail when the portfolio composition changes.
The results of the simulations indicate that the market risk capital regulations do not
provide a `level playing field' for banks that are subject to these regulations. In
addition, giving an option to banks to determine the VaR methodology could create a
moral hazard problem as banks may choose an inaccurate model that provides less
required capital amounts.
History
School
- Business and Economics
Department
- Business
Publisher
© Emrah EksiPublication date
2006Notes
A Doctoral Thesis. Submitted in partial fulfillment of the requirements for the award of Doctor of Philosophy of Loughborough University.EThOS Persistent ID
uk.bl.ethos.432207Language
- en