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Fallacies About the Effects of Market Risk Management Systems
(161k)
(Issue 13, December 2002)
This paper, takes another look at allegations that risk management systems contribute to increased volatility in financial markets, in particular during the summer of 1998. The analysis starts with a review of the literature on the effect of financial engineering on financial markets. The evidence is that financial innovations reduce volatility in financial markets but seem to be systematically blamed for the opposite effect. The paper also provides new evidence on the potential effect of VaR-based market risk charges for commercial banks under the Basel Accord. I show that VaR-based regulatory capital charges cannot plausibly be blamed for the volatility of 1998, due to their very slow response to market movements.
The Impact of the New Basel Accord on the Supply of Capital to Emerging Market Economies
(68k)
(Issue 13, December 2002)
The proposed new Basel Accord aims to ensure that international banks' regulatory capital reflects more closely the credit quality of their loan portfolios. Some commentators are concerned that this might provoke a sharp increase in borrowing costs for debtors domiciled in emerging markets. But the regulatory capital charge will not rise (and may indeed fall) for lending to several emerging markets. And because banks' loan pricing already reflects the borrower's creditworthiness, it seems unlikely that there will be a marked contraction in the supply of loans, even for low credit quality emerging market borrowers.
Bank Capital: Basel II Developments
(87k)
(Issue 13, December 2002)
The Basel Committee on Banking Supervision (BCBS) is in the process of establishing a new Accord ('Basel II') to increase the risk sensitivity of minimum capital requirements for internationally active banks. This will replace the first Basel Accord agreed in 1988. In January 2001, the Committee set out its proposals in a detailed consultation paper (CP2)1. But work has continued since then to ensure that the new rules reflect the risk profiles of different areas of business and achieve the Committee's broad objectives. This has led to a number of revisions to the 2001 proposals.
Modelling Risk in Central Counterparty Clearing Houses: A Review
(116k)
(Issue 13, December 2002)
Central counterparty clearing houses (CCPs) form a core part of the financial market infrastructure in most developed economies. CCPs were established originally to protect market participants from counterparty risk in exchange-traded derivatives markets, but they now also have an important presence in cash and over-the-counter (OTC) derivatives markets. By interposing themselves in transactions, CCPs help to manage counterparty risk for market participants and facilitate the netting of positions. In performing this role, however, CCPs are themselves exposed to various risks. To protect themselves, they have developed various procedures, amongst which the margining of members’ positions plays a central role. This article discusses a range of academic studies which attempt to model the risks faced by CCPs, and which consider how margins and the level of other default resources might be set. It notes that margins alone, calculated to cover losses from typical price movements over one or more days, may not be sufficient to protect CCPs from rare but plausible events. CCPs need to assess the losses they could face on occasions when margin proves insufficient, and ensure that they can meet these losses from extreme events by other means.
Dynamic Provisioning: Issues and Application
(83k)
(Issue 13, December 2002)
This article - a companion to the quantitative analysis of provisioning by UK banks published in the June Review - looks at the pros and cons of 'dynamic' provisioning. In that approach, banks would make provisions based on the losses expected when loans are originated. This would deliver a rising stock of provisions when actual loan losses were unusually low, which would help to protect banks in periods when actual losses were high. In addition, banks' income statements would be less distorted in periods when actual losses were significantly higher or lower than the long-run expected level.
Bank Provisioning: the UK Experience
(123k)
(Issue 12, June 2002)
Bank provisions - made in recognition of a deterioration in loan quality - can have a significant impact on banks' earnings and capital. This article examines the factors that may, in the past, have influenced provisioning by the major UK banks. It suggests that macroeconomic conditions played a particularly important role. Bank-specific factors such as the sectoral concentration of debt, especially if in risky sectors, such as commercial property, were also influential.
