From Basel 1 to Basel 3: The Integration of State-of-the-Art Risk Modeling in Banking Regulation

307 Pages·2006·1.759 MB·English

by  Laurent Balthazar (auth.)

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
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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
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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