Strategic risk, banks, and Basel III: estimating economic capital requirements

Abstract

Purpose -Basel III regulations require banks to protect themselves against strategic risk. This paper aims to provide a comprehensive and measurable definition of this risk and proposes a framework to estimate economic capital requirements.Design/methodology/approach -The paper studies the literature and solicits expert opinion in formulating a comprehensive and measurable definition of strategic risk. The paper postulates that the economic capital for a bank's strategic risk should be estimated using the cost of equity as the profitability threshold, rather than zero and develops a simulation-based framework to estimate economic capital.Findings -The framework closely matches the actual economic capital outlay for strategic risk from our case study of ABN AMRO. It is shown that a bank's strategic growth plans can fall into one of two scenarios based on risk-return characteristics. In one scenario, the required economic capital outlay will increase, and decrease in the other.Practical implications -This framework is generalizable and makes use of widely accepted and used practices in banks, making it readily implementable in practice. It does not introduce errors resulting from model selection, parameterizations or complex calculations.Social implications -Society would be worse off in the absence of banking and lending services. Banks need to take risks to grow and stay competitive. The framework facilitates better strategic risk management, protecting banks from collapse and reducing the need for taxpayer-funded bailouts.Originality/value -The paper provides a measurable and practitioner-verified definition of strategic risk and proposes a simple framework to estimate economic capital requirements, a crucial topic, given the threats and increased levels of strategic risk facing banks.

Bank loan loss provisions research: A review of the empirical literature

“…Similar research was also conducted by (Bryce et al, 2015;Adzis, Tripe, & Dunmore, 2016;Abu-serdaneh, 2018;Isa & Rashid, 2018). Secondly, the suggestion for further research is to conduct LLP behavior investigations during the period after the financial crisis, the suggestion of this research was only responded by several researchers such as (Schwerter & Schwerter, 2015;Cummings & Durrani, 2016;Chockalingam, 2018). Third suggested further research would be more focused on regulatory proposals that can solve several problems about LLP and asymmetry information between agent and principles.…”

“…The first research question is, "Is there evidence of a relationship between LLP and capital ratio policies during the period of implementation of Basel regulations? ", This question has been addressed by several studies such as (Schwerter & Schwerter, 2015;Cummings & Durrani, 2016;Chockalingam, 2018) The second question, "Do managers use opportunistic financial statements or to provide personal information to users of financial statements? ", The question has been addressed by several studies related to management behavior.…”

“…some researchers conducted research related to Basel II regulations (Tschemernjak, 2011;Hudson & Hudson, 2013;Hamadi et al, 2016) Basel III regulations were also the center of attention of several researchers (Lastra, 2014;Schwerter and Schwerter, 2015;Chockalingam, 2018). Based on the directions from the research review (Ozili & Outa, 2017), the research that investigates the impact of loan loss provisions regulation in Basel III and examines whether changes in capital regulation have an impact on the formation of LLP that has been studied (Chockalingam, 2018). Researchers can review Basel III amendment proposals to Basel IV related to (i) increasing capital standards to deal with credit risk, (ii) capital definition specifications and (iii) handling liquidity risk issues (Ozili & Outa, 2017).…”

Factors Affecting Continuance Intention of FinTech Payment among Millennials in Jakarta

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Panel Method in Hedging: Evidence from The Indonesian Agricultural Sector

“…Increased volatility in international markets has driven the use of derivative instruments in controlling financial risks (Ghosh, 2017). Risk control is carried out to reduce various kinds of risks faced, such as exchange rates, commodity price movements, interest rates, and stock prices (Chockalingam, Dabadghao, & Soetekouw, 2018).…”