From Basel 1 to Basel 3: The Integration of State-of-the-Art Risk Modeling in Banking Regulation PDF
Preview From Basel 1 to Basel 3: The Integration of State-of-the-Art Risk Modeling in Banking Regulation
From Basel 1 to Basel 3 The Integration of State-of-the-Art Risk Modeling in Banking Regulation Laurent Balthazar FROM BASEL 1 TO BASEL 3 This page intentionally left blank From Basel 1 to Basel 3: The Integration of State-of-the-Art Risk Modeling in Banking Regulation LAURENT BALTHAZAR ©LaurentBalthazar2006 Softcover reprint of the hardcover 1st edition 2006 978-1-4039-4888-5 Allrightsreserved.Noreproduction,copyortransmissionof thispublicationmaybemadewithoutwrittenpermission. Noparagraphofthispublicationmaybereproduced,copiedor transmittedsavewithwrittenpermissionorinaccordancewith theprovisionsoftheCopyright,DesignsandPatentsAct1988, orunderthetermsofanylicencepermittinglimitedcopying issuedbytheCopyrightLicensingAgency,90TottenhamCourt Road,LondonW1T4LP. Anypersonwhodoesanyunauthorizedactinrelationtothis publicationmaybeliabletocriminalprosecutionandcivil claimsfordamages. Theauthorhasassertedhisrighttobeidentifiedas theauthorofthisworkinaccordancewiththeCopyright, DesignsandPatentsAct1988. Firstpublished2006by PALGRAVEMACMILLAN Houndmills,Basingstoke,HampshireRG216XSand 175FifthAvenue,NewYork,N.Y.10010 Companiesandrepresentativesthroughouttheworld PALGRAVEMACMILLANistheglobalacademicimprintofthePalgrave MacmillandivisionofSt.Martin’sPress,LLCandofPalgraveMacmillanLtd. Macmillan®isaregisteredtrademarkintheUnitedStates,UnitedKingdom andothercountries.PalgraveisaregisteredtrademarkintheEuropeanUnion andothercountries. ISBN 978-1-349-52525-6 ISBN 978-0-230-50117-1 (eBook) DOI 10.1057/9780230501171 Thisbookisprintedonpapersuitableforrecyclingandmadefromfully managedandsustainedforestsources. AcataloguerecordforthisbookisavailablefromtheBritishLibrary. LibraryofCongressCataloging-in-PublicationData Balthazar,Laurent,1976– FromBasel1toBasel3:theintegrationofstateoftheartriskmodelingin bankingregulation/LaurentBalthazar. p.cm.—(Financeandcapitalmarkets) Includesbibliographicalreferencesandindex. 1.Asset-liabilitymanagement—Lawandlegislation.2.Banksand banking—Accounting—Lawandlegislation.3.Banksandbanking, International—Lawandlegislation.I.Title.II.Series. K1066.B352006 346(cid:2).082—dc22 2006043258 10 9 8 7 6 5 4 3 2 1 15 14 13 12 11 10 09 08 07 06 Contents ListofFigures,Tables,andBoxes ix Acknowledgments xiv ListofAbbreviations xv Website xix Introduction 1 Part I Current Banking Regulation 1 Basel 1 5 Bankingregulationsandbankfailures:ahistoricalsurvey 5 TheBasel1988CapitalAccord 16 2 The Regulation of Market Risk: The 1996 Amendment 23 Introduction 23 Thehistoricalcontext 24 AmendmenttotheCapitalAccordtoincorporate marketrisk 27 3 Critics of Basel 1 32 Positiveimpacts 32 Regulatoryweaknessesandcapitalarbitrage 33 Part II Description of Basel 2 4 Overview of the New Accord 39 Introduction 39 GoalsoftheAccord 39 Openissues 40 Scopeofapplication 41 v vi CONTENTS Treatmentofparticipations 42 StructureoftheAccord 44 Thetimetable 47 Summary 47 5 Pillar 1: The Solvency Ratio 49 Introduction 49 Creditrisk–unstructuredexposures–standardized approach 50 Creditrisk–unstructuredexposures–IRBapproaches 58 Creditrisk:securitization 63 Operationalrisk 73 Appendix:Pillar1treatmentofdoubledefaultand tradingactivities 76 6 Pillar 2: The Supervisory Review Process 89 Introduction 89 Pillar2:thesupervisoryreviewprocessinaction 90 Industrymisgivings 93 7 Pillar 3: Market Discipline 95 Introduction 95 Pillar3disclosures 95 Linkswithaccountingdisclosures 96 Conclusions 99 8 The Potential Impact of Basel 2 101 Introduction 101 ResultsofQIS3 101 Comments 104 Conclusions 105 Part III Implementing Basel 2 9 Basel 2 and Information Technology Systems 109 Introduction 109 Systemsarchitecture 109 Conclusions 112 10 Scoring Systems: Theoretical Aspects 114 Introduction 114 TheBasel2requirements 115 Currentpracticesinthebankingsector 117 Overviewofhistoricalresearch 119 CONTENTS vii Thedata 123 Howmanymodelstoconstruct? 126 Modelizationsteps 127 Principlesforratioselection 130 Thelogisticregression 133 Performancemeasures 136 Point-in-timeversusthrough-the-cycleratings 142 Conclusions 144 11 Scoring Systems: Case Study 145 Introduction 145 Thedata 145 Candidateexplanatoryvariables 148 Sampleselection 154 Univariateanalysis 155 Modelconstruction 171 Modelvalidation 175 Modelcalibration 178 Qualitativeassessment 179 Conclusions 181 Appendix1:hypothesisTestforPDestimates 182 Appendix2:commentsonlow-defaultportfolios 187 12 Loss Given Default 188 Introduction 188 LGDmeasures 188 DefinitionofworkoutLGD 189 PracticalcomputationofworkoutLGD 190 Publicstudies 194 StressedLGD 198 Conclusions 199 13 Implementation of the Accord 200 Introduction 200 Internalratingssystems 201 Thequantificationprocess 201 Thedatamanagementsystem 202 Oversightandcontrolmechanisms 203 Conclusions 204 Part IV Pillar 2: An Open Road to Basel 3 14 From Basel 1 to Basel 3 209 Introduction 209 History 209 viii CONTENTS Pillar2 211 Basel3 211 Conclusions 212 15 The Basel 2 Model 214 Introduction 214 Aportfolioapproach 214 TheMertonmodel 217 TheBasel2formula 219 Conclusions 235 16 Extending the Model 237 Introduction 237 Theeffectofconcentration 237 ExtendingtheBasel2framework 238 Conclusions 247 17 Integrating Other Kinds of Risk 248 Introduction 248 Identifyingmaterialrisks 248 Quantificationandaggregation 276 Typicalcapitalcomposition 279 Conclusions 280 Conclusions 283 Overviewofthebook 283 Thefuture 284 Bibliography 286 Index 291 List of Figures, Tables, and Boxes FIGURES 2.1 DJIA:yearlytradingvolume 24 3.1 Securitizationwithrecourse 34 3.2 Remote-originationsecuritization 35 4.1 Scopeofapplicationforafictionalbankinggroup 42 4.2 Treatmentofparticipationsinfinancialcompanies 43 4.3 Treatmentofparticipationsininsurancecompanies 43 4.4 Treatmentofparticipationsincommercialcompanies 44 4.5 Thethreepillars 45 4.6 Solvencyratio 45 5.1 CapitalusingtheSF 71 5.2 CapitalrateusingtheSF 71 5.3 RWAforsecuritizationandcorporateexposures 73 5A.1 EEandEPE 77 5A.2 EPE,EE,andPFE 78 5A.3 EE,EPE,andeffectiveEEandEPE 79 9.1 IncrementalITarchitecture 111 9.2 IntegratedITarchitecture 112 10.1 Currentbankpractices:ratingsystems 118 10.2 Adecisiontree 121 10.3 Aneuralnetwork 121 10.4 ACAPcurve 140 ix
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