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I build a quantitative macro finance model, motivated by empirical findings in Kim (2023) that shows money market mutual funds withdraw from dealer banks with a high return on equity because safe assets issued by issuers with a higher ROE has lower moneyness. The model features a bank that borrows money by issuing a short-term money-like debt with time-varying moneyness. When lenders deem the bank asset too risky -- using the bank's ROE as a proxy -- the short-term debt no longer serves the role of money. An increase in the regulatory capital requirement affects the real economy through three different offsetting channels. [ABSTRACT FROM AUTHOR]

We consider an empirical backtesting for the Solvency Capital Required (SCR) under Solvency II. Based on empirical facts that the Basic own Funds (BoF) can be assumed to evolve log-normally and have a much lower volatility than the corresponding equity for our test data, we make a proposal based on Earnings at Risk (EaR) that can be used to reduce the biases from overshooting SCR estimates in a prudential way. [ABSTRACT FROM AUTHOR]

The objective of this article was to measure the cash flow at risk (CFaR) of non-financial companies in the Brazilian capital market and compare it to shareholders' equity in order to assess the risk of insolvency. Unlike banks and insurance companies, which have strong capital requirements, the current regulation of non-financial institutions in Brazil does not provide for the calculation or maintenance of a minimum shareholders' equity. This study fills a gap in the literature by relating CFaR to the shareholders' equity of entities, providing a measure of insolvency risk. Monitoring insolvency risk (i.e., the possibility of negative shareholders' equity) is critical for any entity, regardless of its industry, market, or size. The results of the CFaR measurement show that companies in different sectors can be exposed to insufficient resources in the event of operational problems. It is hoped that this will help regulators in different sectors to assess minimum capital requirements. CFaR was measured using Ebit and Ebitda (quarterly and annual). The panel consisted of 186 companies listed on the B³ between 2010 and 2022, totaling 4,897 company-quarters. The companies were divided into eight subgroups based on their characteristics. The results showed that non-financial listed companies in the Brazilian market may be undercapitalized, as 18% of the 169 entities that currently have positive shareholders' equity would become negative at a 1% risk level. CFaRs were also reestimated during the pandemic and did not show a clear pattern compared to other periods. [ABSTRACT FROM AUTHOR]

Abstract The objective of this article was to measure the cash flow at risk (CFaR) of non-financial companies in the Brazilian capital market and compare it to shareholders’ equity in order to assess the risk of insolvency. Unlike banks and insurance companies, which have strong capital requirements, the current regulation of non-financial institutions in Brazil does not provide for the calculation or maintenance of a minimum shareholders’ equity. This study fills a gap in the literature by relating CFaR to the shareholders’ equity of entities, providing a measure of insolvency risk. Monitoring insolvency risk (i.e., the possibility of negative shareholders’ equity) is critical for any entity, regardless of its industry, market, or size. The results of the CFaR measurement show that companies in different sectors can be exposed to insufficient resources in the event of operational problems. It is hoped that this will help regulators in different sectors to assess minimum capital requirements. CFaR was measured using Ebit and Ebitda (quarterly and annual). The panel consisted of 186 companies listed on the B³ between 2010 and 2022, totaling 4,897 company-quarters. The companies were divided into eight subgroups based on their characteristics. The results showed that non-financial listed companies in the Brazilian market may be undercapitalized, as 18% of the 169 entities that currently have positive shareholders’ equity would become negative at a 1% risk level. CFaRs were also re-estimated during the pandemic and did not show a clear pattern compared to other periods.

Banks strategically choose and dynamically restructure deposits and nondeposit debt in response to the minimum requirements on total capital and tangible equity. We derive the optimal strategic liability structure and show that it minimizes the protection for deposits conditional on capital requirements. Although, given any liability structure, regulators can set capital requirements high enough to remove the incentive for risk substitution, the strategic response to the capital requirements always preserves this incentive. Banks reduce leverage but increase the proportion of nondeposit debt if regulations raise the capital requirements. This paper was accepted by Lukas Schmid, finance. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4570. [ABSTRACT FROM AUTHOR]

We present an optimization problem to determine the minimum capital requirement for a non-life insurance company. The optimization problem imposes a non-positive Conditional Value-at-Risk (CVaR) of the insurer’s net loss and a portfolio performance constraint. When expressing the optimization problem in a semiparametric form, we demonstrate its convexity for any integrable random variable representing the insurer’s liability. Furthermore, we prove that the function defining the CVaR constraint in the semiparametric formulation is continuously differentiable when the insurer’s liability has a continuous distribution. We use the Kelley-Cheney-Goldstein algorithm to solve the optimization problem in the semiparametric form and show its convergence. An empirical analysis is carried out by assuming three different liability distributions: a lognormal distribution, a gamma distribution, and a mixture of Erlang distributions with a common scale parameter. The numerical experiments show that the choice of the liability distribution plays a crucial role since marked differences emerge when comparing the mixture distribution with the other two distributions. In particular, the mixture distribution describes better the right tail of the empirical distribution of liabilities with respect to the other two distributions and implies higher capital requirements and different assets in the optimal portfolios. [ABSTRACT FROM AUTHOR]

This study compares the liquidity and capital of commercial banks in Tanzania. Specifically, the study examines the liquidity and capital adjustment of small, medium and large banks. The study used quarterly data of 28 commercial banks from 2010 to 2019 and applied descriptive and correlation analysis. Results revealed a negative correlation between adjustment in capital and liquid assets to customer deposits ratio. Furthermore, a significant correlation between capital adjustment and liquidity in small and large banks was also observed. The liquidity and capital adjustment between the current and previous periods do not significantly differ among small, medium, and large banks. However, a significant adjustment from regulatory minimum is observed across banks' group mean. The negative correlation between adjustment in capital and the ratio of liquid assets to customer deposits indicates that banks of higher capital have low liquidity. When capital is adjusted upward, small banks reduce liquidity while large banks increase liquidity. However, when liquidity is adjusted upward, small banks reduce capital while large banks increase capital. When capital requirements increase, the ratio of liquid assets to total assets is reduced for all banks since banks are inclined to increase capital. The results imply heterogeneity of banks' liquidity and capital. Therefore, the regulator should consider heterogeneity among banks to allow effective regulatory and supervisory mechanisms across bank categories. Moreover, bank managers should effectively manage both capital and liquidity to remain legitimate and survive. [ABSTRACT FROM AUTHOR]

The aim of this paper is to analyse all capital buffers that are currently applied in Serbia. Regulation that transposes Basel III regulatory standards in Serbia was adopted in December 2016. These buffers increase the resilience of banks to losses, reduce excessive or underestimated exposures and restrict the distribution of capital. An assessment of the long-term trend of the credit-to-GDP ratio is based on using a one-sided Hodrick-Prescott filter and the selected value of the parameter l equals 400000. Also, this paper used the following methods of research: inductive and deductive methods, methods of analysis and synthesis, classification method and the method of comparison. Analysis has shown that capital buffers that are currently applied in Serbia are fully harmonized with European Union regulations and international best practices.

A computable general equilibrium (CGE) model is used as a regulatory tool for the banking sector in South Africa. The model is used to determine the effects of regulatory penalties, capital adequacy requirements (CAR) and the monetary policy on the economy. Our results indicate that there is a trade‐off between the default and the CAR regulation. For example, when reducing the default penalty, the banks' profits increase, whereas reducing the CAR violation penalty, banks' profits decrease. Changes to the default penalty have a stronger impact than changes in the CAR violation penalty (i.e. when both penalties are reduced, the banks' profits increase). Moreover, regulatory policies that are targeted at different banks produce asymmetric results, as well capitalised banks with richer portfolios swiftly readjust their balance sheet and transfer the default externality to the more constrained banks and/or the private sector agents. [ABSTRACT FROM AUTHOR]

The issue of banks' loss-absorbing capacity (LAC) has been extensively discussed in recent years. That debate was triggered by the idea of a "bail in": the use of certain bank's liabilities to cover losses and recapitalization when it is failing or likely to fail. The objective of this article is to determine the volume of a bank's equity and liabilities available for bail in that would ensure a feasible resolution. To determine that amount, we propose a general quantitative model, considering that the troubled bank must cover its losses (in any resolution path) and restore both its equity and LAC (in the event of recapitalization). One novelty of our approach is that it accounts for the decline in a bank's size as a result of the resolution process and the time-varying regulatory regime (capital requirements). The approach presented in this article makes it possible to determine the amount of LAC required as well as the importance of capital constraints and buffers, which might play a key role in determining the best resolution path. The calculations based on the model under Basel II and Basel III regimes confirm the importance of the time-varying capital buffers to enhance bank resilience. However, if the losses are large, other regulatory actions are required to increase bank LAC. [ABSTRACT FROM AUTHOR]

Credit capital requirement is a key component of Basel implementation to assess a bank's capital adequacy. Under the Internal Rating-Based approach, some risk parameters, including Asset Correlation, are implicit assumptions that cannot be observed directly. While some heuristic formulae of Asset Correlation for different business segments are provided by Basel, they may not be fully consistent with each bank's loss experience and thus may cause systematic underestimation of banks' capital requirement. To address this issue, we derive an equivalent capital formula in such way that the unobservable Asset Correlation is replaced by an observable and well-understood parameter called Default Volatility, which can be calibrated based on banks' historical loss experience. This new approach simplifies parameter estimation process without requiring additional data, as well as making risk analysis such as stress testing more credible. [ABSTRACT FROM AUTHOR]

This article examines the Federal Housing Finance Agency (FHFA)'s 2020 notice of proposed rulemaking (2020 NPR) for the government-sponsored enterprises' capital standards and finds that there are several issues of concern that will distort the relationship between capital and risk. We urge FHFA to better tailor its proposed risk-based capital requirements to the risk and mission of these monoline entities and rely less heavily on a Basel-like framework. We offer a package of specific adjustments that will better align capital with risk, without reducing the overall rigor or stringency of the capital standard. Better tying capital to risk will result in a better regulated and stronger mortgage finance system. [ABSTRACT FROM AUTHOR]

We investigate the optimal design and effectiveness of monetary and macroprudential policies in promoting macroeconomic (price) and financial stability for the South African economy. We develop a New Keynesian dynamic stochastic general equilibrium model featuring a housing market, a banking sector and the role of macroprudential and monetary policies. Based on the parameter estimates from the estimation, we conduct an optimal rule analysis and an efficient policy frontier analysis, and compare the dynamics of the model under different policy regimes. We find that a policy regime that combines a standard monetary policy rule and a macroprudential policy rule delivers a more stable economic system with price and financial stability. A policy regime that combines an augmented monetary policy (policy rate reacts to financial conditions) with macroprudential policy is better at attenuating the effects of financial shocks, but at a much higher cost of price instability. Our findings suggest that monetary policy should focus solely on its primary objective of price stability and let macroprudential policy facilitate financial stability on its own. [ABSTRACT FROM AUTHOR]

We analyze the design and impact of bank regulation using a dynamic structural framework. The optimal regulatory policy combines a target capital requirement, the mitigation of underinvestment, an intervention capital requirement to control inefficient risk taking, and recapitalization of distressed banks. The optimal target and intervention capital requirements from our structural estimation are consistent with the substantially higher capital requirements proposed in Basel III and together achieve most of the regulatory benefits by alleviating underinvestment and asset substitution. They are interdependent and respond differently to banks' asset characteristics, thereby suggesting that regulatory policies should be carefully tuned to the economic environment. This paper was accepted by Kay Giesecke, finance. [ABSTRACT FROM AUTHOR]

This paper looks at the impact of the new resolution regime, especially the bail-in tools, on balance sheet management and the implications for internal liquidity risk management as well as funding. Minimum Requirement for own funds and Eligible Liabilities (MREL) and total loss-absorbing capacity (TLAC) should be key indicators for total bank management. Due to costintensity, the paper advises optimising the balance sheet structure and the resolution strategy. A prudent funding strategy has to find a balance between the firm-specific funding capacity, continuous market access and limiting costs. The paper also looks at an efficient way to allocate the specific costs within the bank. [ABSTRACT FROM AUTHOR]

Capital buffers can improve the stability of the banking system, but they come at a cost. This study explores the efficient macro-prudential regulation of systemic risk from the perspective of capital network reconstruction. A model of option pricing is proposed to determine the market value of sector credits. Consequently, systemic risk is measured by both credit and interbank contagion risks. Credit network reconstruction is then optimized to minimize systemic risks. Our analysis was based on data from China's banking systems between 2008 and 2020. In different stress tests, the credit network reconstruction generally optimizes systemic risk to the lowest level. At the same time, it may save about 20% to 140% of the cost of capital. The optimization mechanism analysis shows that large banks with stability advantages share more shocks than small banks by reconstructing their sector credit network. As a result, the contagion process of systemic risk is prevented, and bankruptcy cascades are eliminated. These results imply that credit network reconstruction holds great potential for preventing systemic risks. • Credit network reconstruction has more advantages of efficiency in preventing systemic risk than capital requirements. • Systemic risk optimization is optimized through increased common credits where big banks share more shocks from the other banks. • Stability of the banking system is promoted when big banks take more risks than their market shares. [ABSTRACT FROM AUTHOR]