Do banks’ internal Basel risk estimates reflect risk?

Barakova, Irina; Palvia, Ajay A.

doi:10.1016/j.jfs.2014.05.005

Cited by 34 publications

(23 citation statements)

References 16 publications

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“…In the robustness check, we use Tier 1 and Tier 2 capital ratios to replace Z-score as a measure of capital adequacy and results are similar. For a related study, see,Barakova (2014).…”

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confidence: 99%

The Determinants of Global Bank Credit-Default-Swap Spreads

2015

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Using a sample of 161 global banks in 23 countries, we examine the applicability of market-based structural models and accounting-based bank fundamentals to price global bank credit risk. First, we find that variables predicted by structural models are significantly associated with bank CDS spreads. Second, some CAMELS indicators contain incremental information for bank CDS prices. We find no evidence in favor of one model over the other, while the combined structural and CAMELS model performs better than each individual model. Moreover, leverage and asset quality have had a stronger impact on bank CDS since the onset of the recent financial crisis. Banks in countries with lower stock market volatility, fewer entry barriers, and/or more financial conglomerate restrictions tend to have lower credit risk. Deposit insurance appears to have an adverse effect on bank CDS spreads, indicating a moral hazard problem.

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“…In the robustness check, we use Tier 1 and Tier 2 capital ratios to replace Z-score as a measure of capital adequacy and results are similar. For a related study, see,Barakova (2014).…”

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confidence: 99%

The Determinants of Global Bank Credit-Default-Swap Spreads

2015

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“…The banking authorities (BCBS, 2016;EBA, 2016;ECB Banking Supervision, 2017) have already addressed these criticisms and in the overall there is a general consensus on the validity of the IRB framework as a risk-sensitive way to measure capital requirements ( Barakova and Palvia, 2014;Colliard, 2015;Resti, 2016;Huizinga, 2016).…”

Section: The Irb Approach In the Literaturementioning

confidence: 99%

Credit Risk in European Banks: The Bright Side of the Internal Ratings Based Approach

et al. 2017

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This is the accepted version of the paper.This version of the publication may differ from the final published version.Permanent repository link: https://openaccess.city.ac.uk/id/eprint/22694/ Link to published version: http://dx. AbstractThis paper investigates the accuracy of internal rating based (IRB) models in measuring credit risk. We contribute to the growing debate on the current prudential regulatory framework by investigating the use of validated IRB models in promoting efficient risk management practises. Our empirical analysis is based on a novel panel data set of 177 Western European banks observed from 2008 to 2015, in the aftermath of the financial and economic crisis. We find that IRB banks were able to curb the increase in credit risk driven by the macroeconomic slowdown better than banks under the standardized approach. This suggests that the introduction of the internal ratings based approach by Basel II has promoted the adoption of stronger risk management practices among banks, as meant by the regulators. Ref: R&R Review of "Credit risk in European banks: The bright side of the IRB approach" Ms. Ref. No.: JBF-D-17-00246Dear Reviewer #2, Thank you for your attentive reading of the paper and for your further comments. We are happy that you appreciate our efforts to follow your guidance. We are very grateful for your suggestions and we have tried to implement as many as we could in this latest version of the paper.In what follows we explain how we revised the paper on the base of your comments, highlighting the major changes with respect to its previous version. We also discuss how we accounted for those comments that we could not investigate directly due to data availability.We wish to thank you very much for guiding us through this extensive revision process and particularly for directing our efforts towards a justifiable econometric approach to support our findings. Best regards, The AuthorsAbstract This paper investigates the accuracy of internal rating based (IRB) models in measuring credit risk. We contribute to the growing debate on the current prudential regulatory framework by investigating the use of validated IRB models in promoting efficient risk management practises. Our empirical analysis is based on a novel panel data set of 177 Western European banks observed from 2008 to 2015, in the aftermath of the financial and economic crisis. We find that IRB banks were able to curb the increase in credit risk driven by the macroeconomic slowdown better than banks under the standardized approach. This suggests that the introduction of the internal ratings based approach by Basel II has promoted the adoption of stronger risk management practices among banks, as meant by the regulators.

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“…Papers in this vein most closely related to our study are Barakova and Palvia (2014) and Vallascas and Hagendorff (2013). Barakova and Palvia (2014) examine the relation of RWA and a range of accounting and market-based risk measures.…”

Section: Relation To the Literaturementioning

confidence: 99%

“…Barakova and Palvia (2014) examine the relation of RWA and a range of accounting and market-based risk measures. They document stronger correlations of accounting risk measures (e.g., loan performance) with Basel II risk weights than with Basel I risk weights.…”

Section: Relation To the Literaturementioning

confidence: 99%

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Revisiting Basel risk weights: cross-sectional risk sensitivity and cyclicality

Baule

Tallau

2016

J Bus Econ

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We empirically assess the sensitivity of Basel risk weights to bank portfolio risk and the business cycle. With our econometric model, we distinguish between cross-sectional risk sensitivity and longitudinal risk sensitivity (cyclicality) of the regulatory standard. Employing a comprehensive data set covering 200 large banks from 28 countries, we find that actual risk weights are fairly insensitive to the business cycle. There is no evidence that Basel II has significantly increased cyclicality. Furthermore, cross-sectional risk sensitivity of regulatory risk weights to a market measure of bank portfolio risk is low. We further assess the adequacy of the capital standard's risk sensitivity based on a Merton-style model of bank risk and bank default. Judged upon the Basel Committee's self-established goal of maintaining bank default rates below 0.1 %, our results suggest that risk weights and minimum capital requirements are ill-calibrated, even under the stricter Basel III rules.

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Do banks’ internal Basel risk estimates reflect risk?

Cited by 34 publications

References 16 publications

The Determinants of Global Bank Credit-Default-Swap Spreads

The Determinants of Global Bank Credit-Default-Swap Spreads

Credit Risk in European Banks: The Bright Side of the Internal Ratings Based Approach

Revisiting Basel risk weights: cross-sectional risk sensitivity and cyclicality

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