Risk-based bank capital: Issues and solutions

Neither the standardized model or the internal model approach permits the design of a system of rewards and penalties that would align the incentives of bank management with those of regulatory authorities. The precommitment approach, if carefully implemented, can achieve the desired incentive compa...

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Bibliographic Details
Published in:Economic review (Atlanta, Ga.) Ga.), 1995-09, Vol.80 (5), p.32
Main Author: Bliss, Robert R
Format: Article
Language:English
Subjects:
Bank portfolios
Banking industry
Banks
Bans
Commercial banks
Credit risk
Economics
Foreign exchange markets
Foreign exchange rates
Interest rates
International finance
Portfolio management
Regulation of financial institutions
Risk capital
Risk management
Safety & soundness
Securities markets
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Summary:Neither the standardized model or the internal model approach permits the design of a system of rewards and penalties that would align the incentives of bank management with those of regulatory authorities. The precommitment approach, if carefully implemented, can achieve the desired incentive compatibility. Regulators should avoid the temptation to micromanage banks' models and should focus instead on the outputs. Both the standardized and internal models' approaches to risk-based capital have serious disadvantages. Regulations regarding how actual losses are to be compared with a model's VAR predictions are reasonable, as are actions to be taken and penalties to be imposed when the model's forecasts prove inadequate. In the absence of evidence of gross problems, the focus should be on the precommitment levels and loss experience. The precommitment approach can enable regulators to identify and focus their efforts on problem banks while providing incentives for the majority of banks to stay out of trouble without constant, detailed oversight.
ISSN:0732-1813
2163-3258