Does CRDIV provide an efficient way to deal with banks' simultaneous defaults?

The Capital Requirement Directive IV issues detailed rules on the new global regulatory standards for bank capital adequacy. Among others, it requires all instruments in the additional Tier 1 layer of a credit institution to be written down or converted into equity, as soon as the Common Equity Tier 1 capital falls below 5.125% of risk weighted assets. Whether or not the new framework is making the banking sector more resilient, there is still one issue regulators have never dealt with. What the Basel accord imposes to each bank is a regulatory minimum capital meant to cover unexpected losses as the banks were isolated entities. But, in reality, banks are exposed to common borrowers. The present study performs a quantitative assessment of banks being part of a common economic environment. We use a micro simulation portfolio model to estimate the aggregate distribution of bank losses assuming banks are interconnected via a correlation structure and, possibly, a contagion network. Our results show that systemic loss in the presence of a correlation across banks is 5% higher than what the system may experience without. The increase raises up to 40% when adding second effects.We define a series of possible rules for allocating extra capital to annihilate the losses due to commonalities. We show that the regulatory rule of requiring extra capital as soon as the common equity falls down the 5.125% of risk weighted assets is more efficient than asking GSIBs or all banks to increase their Common Equity Tier 1. Results provide evidence that the allowance of debt instruments in the additional Tier 1 of being converted into equity may be an efficient macro-prudential tool to face banks' simultaneous defaults and would help in dealing with the missing piece in the Basel framework.

DI GIROLAMO Francesca;  PAGANO Andrea;  PETRACCO GIUDICI Marco; 

2018-02-22

Società editrice il Mulino

JRC103516

2282-717X,   

https://www.rivisteweb.it/doi/10.12831/88827,    https://publications.jrc.ec.europa.eu/repository/handle/JRC103516,   

10.12831/88827,