Bank regulation and international financial stability: A case against the 2006 Basel framework for controlling tail risk in trading books |
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| Affiliation: | 1. University of Minnesota, Department of Finance, Carlson School of Management, Room 3-110, 321-19th, Avenue South, Minneapolis, MN 55455, United States;2. The George Washington University, The George Washington University, School of Business, 2201 G Street, NW, Funger Hall, Suite 501, Washington, DC 20052, United States;3. University of South Carolina, University of South Carolina, The Moore School of Business, Finance Department, Columbia, SC 29208, United States;1. Owen Graduate School of Management, Vanderbilt University, USA;2. Department of Economics, Santa Clara University, USA;1. Department of Finance, Insurance and Real Estate, Faculty of Business Administration, Laval University, 2325, rue de la Terrasse, Pavillon Palasis-Prince, Quebec, Canada;2. Laboratory for Financial Engineering of Laval University, Department of Finance, Insurance and Real Estate, Faculty of Business Administration, Laval University, 2325, rue de la Terrasse, Pavillon Palasis-Prince, Quebec, Canada;3. IPAG Business School, Paris, France;1. Aarhus University, Fuglesangs Allé 4, Aarhus 8000 C, Denmark;2. True North Institute, 145-147 St. John Street, London EC1V 4PY, United Kingdom;3. Georgia Institute of Technology, H. Milton Stewart School of Industrial and Systems Engineering, Atlanta, GA, USA;4. Frankfurt School of Finance and Management, Sonnemannstraße 9-11, 60314 Frankfurt, Germany;5. German Savings Bank Association, Charlottenstraße 47, 10117 Berlin, Germany;1. Centre of Planning and Economic Research (KEPE), 11, Amerikis str., 106 72, Athens, Greece;2. Centre of Planning and Economic Research (KEPE), Greece & Hellenic Open University (HOU), Greece;1. College of Business and Economics, Department of Accounting and Finance, UAE University, United Arab Emirates;2. College of Science, Department of Mathematical Sciences, UAE University, United Arab Emirates;1. Missouri Western State University, Saint Joseph, MO 64507, USA;2. Drexel University, Philadelphia, PA 19104, USA |
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| Abstract: | In attempting to promote international financial stability, the Basel Committee on Banking Supervision (2006) provided a framework that sought to control the amount of tail risk that large banks around the world would take in their trading books relative to their corresponding minimum capital requirements. However, many of these banks suffered significant trading losses during the recent financial crisis. Our paper examines whether the Basel framework allowed banks to take substantive tail risk in their trading books without a capital requirement penalty. We find that it allowed banks to do so and that its minimum capital requirements can be notably procyclical. Hence, focusing on the way the Basel framework sought to control the amount of tail risk in trading books relative to their corresponding minimum capital requirements, our paper supports the view that it was not properly designed to promote financial stability. We also discuss alternative regulatory frameworks that would potentially be more effective than the Basel framework in preventing banks from taking substantive tail risk in their trading books without a capital requirement penalty. |
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| Keywords: | Bank regulation Financial stability Basel framework Financial crisis Tail risk G11 G21 G28 D81 |
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