Copula-Based Formulas to Estimate Unexpected Credit Losses (The Future of Basel Accords?)

The model used to estimate the capital required to cover unexpected credit losses in financial institutions (Basel II) has some drawbacks that reduce its ability to capture potential joint extreme losses in downturns. This paper suggests an alternative approach based on Copula Theory to overcome such flaws. Similarly to Basel II, the suggested model assumes that defaults are driven by a latent variable which varies as a response to an unobserved factor. On the other hand, the use of copulas allows the identification of asymmetric dependence between defaults which has been registered in the literature. As an example, a specific copula family (Clayton) is adopted to represent the association between the latent variables and a formula to estimate potential unexpected losses at a certain level of confidence is derived. Simulations reveal that, in most of the cases, the alternative model outperforms Basel II for portfolios with right-tail-dependent probabilities of default (supposedly, a good representation for real loan portfolios)

ERM Adoption in the Insurance Sector – Is it a Regulatory Imperative or Business Value Driven?

Purpose - This paper aims to investigate various institutional pressures driving the adoption and implementation of a new risk management system; enterprise risk management (ERM). Design/methodology/approach - The implementation of ERM-related practices is analysed based on an institutional framework and drawing on empirical evidence from multiple sources in 10 large/medium-sized insurance companies. This paper focuses on extraorganisational pressures exerted by political, social and economic institutions on insurance companies, which drove the adoption decision. Findings - It was found that different change agents have taken part in the decision to introduce new risk management system as a part of ERM implementation process. Further, the institutional pressures; coercive, mimetic and normative, were found to differ in character and strength over different intervals of time in relation to the adoption of ERM. Companies that adopted ERM early were mostly driven by internal strategic drivers while the recent adoption decision was more driven by coercive and mimetic pressures. Thus, evidence of divergence between insurance companies was found. Research limitations and implications - The findings have implications for policy makers, regulatory agencies and innovation developers. ERM was considered not only as a necessity but also as a value added to the insurance companies under study. Thus, regulators and innovation developers should survey main players in any specific organisational field to understand their views before issuing new compulsory regulations or developing innovations. They also need to consider exploring companies' experiences with ERM, which can provide a basis for the development of strengthened and more informative regulatory ERM frameworks. This will support a faster and easier understanding and implementation of ERM framework hindered by the confusions companies may face when considering the complicated/changing regulatory and risk requirements. Originality/value - This study extends the scope of institutional analysis to the risk management field, particularly ERM and to the explanation of how different institutions affect the decision to move towards ERM and modify the risk management rules applied within the organisational environment. It looks not only at convergences but also divergences associated with the period of time when ERM adoption decision was made. Thus, it develops a processual view of change

Implementing Loss Distribution Approach for Operational Risk

To quantify the operational risk capital charge under the current regulatory framework for banking supervision, referred to as Basel II, many banks adopt the Loss Distribution Approach. There are many modeling issues that should be resolved to use the approach in practice. In this paper we review the quantitative methods suggested in literature for implementation of the approach. In particular, the use of the Bayesian inference method that allows to take expert judgement and parameter uncertainty into account, modeling dependence and inclusion of insurance are discussed

Robust Estimators in Generalized Pareto Models

This paper deals with optimally-robust parameter estimation in generalized Pareto distributions (GPDs). These arise naturally in many situations where one is interested in the behavior of extreme events as motivated by the Pickands-Balkema-de Haan extreme value theorem (PBHT). The application we have in mind is calculation of the regulatory capital required by Basel II for a bank to cover operational risk. In this context the tail behavior of the underlying distribution is crucial. This is where extreme value theory enters, suggesting to estimate these high quantiles parameterically using, e.g. GPDs. Robust statistics in this context offers procedures bounding the influence of single observations, so provides reliable inference in the presence of moderate deviations from the distributional model assumptions, respectively from the mechanisms underlying the PBHT.Comment: 26pages, 6 figure

Bank regulation and stock market stability across countries

© 2016, © Emerald Group Publishing Limited. Purpose: The purpose of this paper is to investigate whether bank capital strength and external auditing requirements influenced international stock market stability during the 2007/2008 global financial crisis. Design/methodology/approach: Bank mandatory regulation data are obtained from the World Bank database, while stock market stability is gauged for 385 listed banks across 43 countries by means of generalised least squares regression models. Findings: The authors find that mandatory capital strength requirements and the existence of mandatory audit increase stock market stability across countries. Further, more profitable banks increase stock market stability. The results are robust to both country institutional settings and economic freedom characteristics. Originality/value: This paper provides evidence of the impact of bank regulations on stock market stability during the global financial crisis, thereby providing a useful insight for stakeholders to enhance financial regulation and policy