Macroprudential Regulation: A Risk Management Approach
Published: 06 February 2023
We use market-based estimates of systemic risk and a structural framework for credit risk assessment to address the problem of regulating banks’ macroprudential capital buffers. We sketch three approaches to allocating capital buffers across systemic banks: equalizing the expected impact between systemic and non-systemic institutions, minimizing aggregate systemic risk, and balancing the social costs and benefits of capital requirements. In our application to the European banking sector we find substantial differences with current capital requirements. Capital buffers play a key role in managing banks’ contributions to systemic distress, so our findings have material implications for systemic risk in the EEA.
Keywords: systemic risk; regulation; capital buffers; implied market measures; financial institutions; CDS rates
JEL codes G01; G20; G18; G38
Working paper no. 765
765 - Macroprudential Regulation: A Risk Management Approach
765- Macroprudential Regulation: A Risk Management Approach
Research Highlights
- We address the problem of regulating the size of banks' macroprudential capital buffers by using market-based estimates of systemic risk combined with a structural framework for credit risk assessment.
- We develop a set of novel modeling mechanisms through which capital buffers can be allocated across systemic banks: (1) equalizing the expected impact between a systemic and a non-systemic institution; (2) minimizing the aggregate systemic risk; (3) balancing the social costs and benefits of higher capital requirements.
- We apply the model to the European banking sector and find sometimes substantial differences with the capital buffers currently assigned by national regulators.
- Since capital buffers are one of the main policy instruments for managing banks’ potential contributions to systemic distress, our findings have substantial implications for systemic risk in the EEA.
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