Financial Services at the Crossroads: Capital Regulation in ...

Federal Reserve Bank of New York

Economic Policy Review October1998

Volume 4 Number 3

Proceedings of a Conference

Financial Services at the Crossroads: Capital Regulation in the Twenty-First Century

Sponsored by the Federal Reserve Bank of New York in collaboration with the Bank of England, the Bank of Japan, and the Board of Governors of the Federal Reserve System

EDITOR PAUL B. BENNETT

ASSOCIATE EDITORS REBECCA S. DEMSETZ KENNETH N. KUTTNER PHILIP E. STRAHAN

JOSEPH S. TRACY

EDITORIAL STAFF Valerie LaPorte Mike De Mott

Elizabeth Miranda

PRODUCTION STAFF Carol Perlmutter Lingya Dubinsky Jane Urry

The ECONOMIC POLICY REVIEW is published by the Research and Market Analysis Group of the Federal Reserve Bank of New York. The views expressed in the articles are those of the individual authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.

FEDERAL RESERVE BANK OF NEW YORK

ECONOMIC POLICY REVIEW ADVISORY BOARD

Andrew Abel Wharton, University of Pennsylvania

Ben Bernanke Princeton University

Timothy Bollerslev University of Virginia

Charles Calomiris Columbia University

Richard Clarida Columbia University

John Cochrane University of Chicago

Stephen Davis University of Chicago

Francis X. Diebold University of Pennsylvania

Franklin Edwards Columbia University

Henry S. Farber Princeton University

Mark Flannery University of Florida, Gainesville

Mark Gertler New York University

Gary Gorton Wharton, University of Pennsylvania

James D. Hamilton University of California, San Diego

Bruce E. Hansen Boston College

John Heaton Northwestern University

Richard J. Herring Wharton, University of Pennsylvania

Robert J. Hodrick Columbia University

R. Glenn Hubbard Columbia University

Christopher M. James University of Florida, Gainesville

Kose John New York University

Edward Kane Boston College

Deborah Lucas Northwestern University

Richard Lyons University of California, Berkeley

Frederic S. Mishkin Columbia University

Maurice Obstfeld University of California, Berkeley

Raghuram G. Rajan University of Chicago

Kenneth Rogoff Princeton University

Christopher Sims Yale University

Kenneth D. West University of Wisconsin

Stephen Zeldes Columbia University

Federal Reserve Bank of New York Economic Policy Review

Table of Contents October1998 Volume 4 Number 3

Financial Services at the Crossroads: Capital Regulation in the Twenty-First Century Proceedings of a Conference Held at the Federal Reserve Bank of New York on February 26-27, 1998

1

CONFERENCE OVERVIEW: MAJOR THEMES AND DIRECTIONS FOR THE FUTURE

William J. McDonough

7

OPENING REMARKS

Chester B. Feldberg

SESSION 1: IMPACT OF CAPITAL REQUIREMENTS ON BANK RISK TAKING: EMPIRICAL EVIDENCE

15

THE IMPACT OF CAPITAL REQUIREMENTS ON U.K. BANK BEHAVIOUR

Tolga Ediz, Ian Michael, and William Perraudin

23

ASSESSING THE IMPACT OF PROMPT CORRECTIVE ACTION ON BANK CAPITAL AND RISK

Raj Aggarwal and Kevin T. Jacques

33

FAIR VALUE ACCOUNTING AND REGULATORY CAPITAL REQUIREMENTS

Tatsuya Yonetani and Yuko Katsuo

45

MEASURING THE RELATIVE MARGINAL COST OF DEBT AND CAPITAL FOR BANKS

Thuan Le and Kevin P. Sheehan

47

COMMENTARY

Stephen G. Cecchetti

SESSION 2: CREDIT RISK MODELING

53

INDUSTRY PRACTICES IN CREDIT RISK MODELING AND INTERNAL CAPITAL ALLOCATIONS: IMPLICATIONS

FOR A MODELS-BASED REGULATORY CAPITAL STANDARD

David Jones and John Mingo

61

CREDIT RISK IN THE AUSTRALIAN BANKING SECTOR

Brian Gray

71

PORTFOLIO CREDIT RISK

Thomas C. Wilson

83

CAPITAL ALLOCATION AND BANK MANAGEMENT BASED ON THE QUANTIFICATION OF CREDIT RISK

Kenji Nishiguchi, Hiroshi Kawai, and Takanori Sazaki

95

COMMENTARY

William Perraudin

DISTINGUISHED ADDRESS

99

SUPERVISORY CAPITAL STANDARDS: MODERNISE OR REDESIGN?

Edgar Meister

SESSION 3: ISSUES IN VALUE-AT-RISK MODELING AND EVALUATION

107

THE VALUE OF VALUE AT RISK: STATISTICAL, FINANCIAL, AND REGULATORY CONSIDERATIONS

Jon Danielsson, Casper G. de Vries, and Bj?rn N. J?rgensen

109

HORIZON PROBLEMS AND EXTREME EVENTS IN FINANCIAL RISK MANAGEMENT

Peter F. Christoffersen, Francis X. Diebold, and Til Schuermann

119

METHODS FOR EVALUATING VALUE-AT-RISK ESTIMATES

Jose A. Lopez

125

COMMENTARY

Beverly Hirtle

SESSION 4: INCENTIVE-COMPATIBLE REGULATION: VIEWS ON THE PRECOMMITMENT APPROACH

131

PILOT EXERCISE--PRE-COMMITMENT APPROACH TO MARKET RISK

Jill Considine

137

VALUE AT RISK AND PRECOMMITMENT: APPROACHES TO MARKET RISK REGULATION

Arupratan Daripa and Simone Varotto

145

DESIGNING INCENTIVE-COMPATIBLE REGULATION IN BANKING: THE ROLE OF PENALTY

IN THE PRECOMMITMENT APPROACH

Shuji Kobayakawa

155

COMMENTARY

Patrick Parkinson

KEYNOTE ADDRESS

161

THE ROLE OF CAPITAL IN OPTIMAL BANKING SUPERVISION AND REGULATION

Alan Greenspan

SESSION 5: INTERNATIONAL CAPITAL ALLOCATION AT FINANCIAL INSTITUTIONS

171

BUILDING A COHERENT RISK MEASUREMENT AND CAPITAL OPTIMISATION MODEL FOR FINANCIAL FIRMS

Tim Shepheard-Walwyn and Robert Litterman

183

CAPITAL FROM AN INSURANCE COMPANY PERSPECTIVE

Robert E. Lewis

187

COMMENTARY

Masatoshi Okawa

SESSION 6: THE ROLE OF CAPITAL REGULATION IN BANK SUPERVISION

191

FORMULAS OR SUPERVISION? REMARKS ON THE FUTURE OF REGULATORY CAPITAL

Arturo Estrella

201

DEPOSIT INSURANCE, BANK INCENTIVES, AND THE DESIGN OF REGULATORY POLICY

Paul H. Kupiec and James M. O'Brien

213

ISSUES IN FINANCIAL INSTITUTION CAPITAL IN EMERGING MARKET ECONOMIES

Allen B. Frankel

225

COMMENTARY

Christine M. Cumming

SESSION 7: THE FUTURE OF CAPITAL REGULATION

231

CAPITAL REGULATIONS: THE ROAD AHEAD

Tom de Swaan

237

RISK MANAGEMENT: ONE INSTITUTION'S EXPERIENCE

Thomas G. Labrecque

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