Regulation of Bank Capital and Portfolio Risk

Koehn, Michael F.; Santomero, Anthony M.

doi:10.1111/j.1540-6261.1980.tb02206.x

Cited by 674 publications

(318 citation statements)

References 12 publications

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“…An important component of this cost is caused by behavioral adjustments that are not intended. The present contribution belongs to this tradition of research, which dates back at least to Koehn and Santomero (1980). Characterizing a bank by its utility function and assuming it to optimize a portfolio containing both assets and liabilities, they find that imposing a simple equity-to-assets ratio constraint is ineffective on average.…”

Section: Solvency Regulation Of Insurersmentioning

confidence: 99%

Solvency Regulation of Banks and Insurers: A Two-Pronged Critique

Zweifel

2015

International Journal of Financial Research

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This paper puts forth two models, one of a bank and one of an insurer. Their divisions responsible for investment (and risk underwriting, respectively) seek to maximize the expected risk-adjusted rate of return on capital (RAROC). For the bank, higher solvency lowers the cost of refinancing; for the insurer, it attracts more premium income. In both cases, however, higher solvency ties costly capital. Sequential decision making is tracked over three periods. In period 1, exogenous changes in expected returns and in volatility occur, each suggesting optimal adjustments in solvency. However, there can be only one adjustment, which in period 3 creates an endogenous trade-off between expected returns and volatility. This tradeoff is shown to involve parameters that differ between banks and insurers, calling for bank-specific and insurance-specific solvency regulation. In addition, Basel I and II (Solvency I and II, respectively) are shown to modify this tradeoff, inducing senior management of both banks and insurers to opt for higher volatility and lower solvency than otherwise. Therefore, existing solvency regulation can run counter their stated objective in both cases, which quite likely is also true of Basel III and Solvency III.

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Section: Solvency Regulation Of Insurersmentioning

confidence: 99%

Solvency Regulation of Banks and Insurers: A Two-Pronged Critique

Zweifel

2015

International Journal of Financial Research

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“…However, the relationship between bank capital and risk under a capital adequacy requirement remains, to date, inconclusive. In the theory literature, Koehn and Santomero (1980) and Kim and Santomero (1988), using a mean-variance framework, show that increased regulatory capital standards may lead banks to choose risky portfolios to cover the loss in utility from the decrease in leverage. Conversely, Furlong and Keeley (1989) and Keeley and Furlong (1990) argue, using a contingent-claim model, that an increase in capital reduces the value of the deposit insurance put option, thereby reducing the incentive of banks to increase portfolio risk.…”

Section: Introductionmentioning

confidence: 99%

Bank capital shocks and portfolio risk: Evidence from Japan

Iwatsubo

2007

Japan and the World Economy

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Despite the downward trend of land prices and the ex-post low return on real estate loans, Japanese banks increased their lending to the real estate sector during the 1990s. We argue that this phenomenon can be explained by the risk-shifting incentives of banks and discover that banks with low capital-to-asset ratios and low franchise value chose high-risk assets such as real estate loans. Unlike previous studies, we show that the capital-risk relationship is nonlinear and changes from positive to negative as franchise value falls. We also …nd that a capital adequacy requirement did not prevent risk-taking behavior of undercapitalized banks since they then just issued more subordinated debts to meet this requirement. In contrast, government capital injections led banks to reduce risky loans at the margin. Recapitalization by issuing subordinated debts helped banks recover their capital losses and mitigated the credit crunch, but consequently allowed them to increase their exposure to the real estate sector and worsened the bad loan problems.

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“…The decision making process in terms of risk-return of different industries is also investigated by many studies throughout the world. The rates of return on assets or equity (ROA/ROE) (see e.g., Blair and Heggestad, 1978;Hart and Jaffee, 1974;Koehn and Santomero, 1980;etc. ) from the viewpoints of the managers and shareholders, and also Capital ratios (see e.g., Brewer and Lee, 1986;and International Monetary Fund, 1990) from the perspectives of regulators and financial markets and their practitioners receive increasing attention in this regard.…”

Section: Risk and Return Measurementmentioning

confidence: 99%

Behavioral Implications of Risk-Return Associations: An Application of Prospect Theory on CNX NIFTY Companies

Dasgupta¹

2017

AABFJ

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This study primarily investigates the risk attitudes of the fifty CNX NIFTY companies from a behavioral perspective as proposed by Kahneman and Tversky (1979) and Tversky and Kahneman (1992). It hypothesizes that for below target returns, a large majority of Indian companies would be risk-seeking, and for above target returns, most of them would be risk-averse. To fulfil its objectives, this study uses rates of return on assets and equity and the capital ratios of fifty CNX NIFTY companies over the period [2009][2010][2011][2012][2013]. It also uses Kendall's (1938) AbstractThis study primarily investigates the risk attitudes of the fifty CNX NIFTY companies from a behavioral perspective as proposed by Kahneman and Tversky (1979) and Tversky and Kahneman (1992). It hypothesizes that for below target returns, a large majority of Indian companies would be risk-seeking, and for above target returns, most of them would be riskaverse. To fulfil its objectives, this study uses rates of return on assets and equity and the capital ratios of fifty CNX NIFTY companies over the period -2013. It also uses Kendall's (1938 test to measure the correlations between above variables within the relevant groups (all companies and each sub group [under Size and Industry]). Results show that bigger and smaller Indian companies and their managers are mostly risk-seeking and risk-averse respectively and shareholders-centric in regard to their attitude. These results will have important implications for the Indian companies and managers in evaluating their risk attitudes from the behavioral perspective.JEL Classification: E37, F37, G12

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Regulation of Bank Capital and Portfolio Risk

Cited by 674 publications

References 12 publications

Solvency Regulation of Banks and Insurers: A Two-Pronged Critique

Solvency Regulation of Banks and Insurers: A Two-Pronged Critique

Bank capital shocks and portfolio risk: Evidence from Japan

Behavioral Implications of Risk-Return Associations: An Application of Prospect Theory on CNX NIFTY Companies

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