Competition and risk taking by Spanish banks
Evaluating interest rate covariance models within a value-at-risk framework
We find that covariance matrix forecasts for an international interest rate portfolio generated by a model that incorporates interest-rate level volatility effects perform best with respect to statistical loss functions. However, within a value-at-risk (VaR) framework, the relative performance of the covariance matrix forecasts depends greatly on the VaR distributional assumption. Simple forecasts based just on weighted averages of past observations perform best using a VaR framework. In fact, we find that portfolio variance forecasts that ignore the individual assets in the portfolio ...
How does competition impact bank risk-taking?
A common assumption in the academic literature and in the actual supervision of banking systems worldwide is that franchise value plays a key role in limiting bank risk-taking. As the underlying source of franchise value is assumed to be market power, reduced competition has been considered to promote banking stability. Boyd and De Nicolo (2005) propose an alternative view where concentration in the loan market could lead to increased borrower debt loads and a corresponding increase in loan defaults that undermine bank stability. Martinez-Miera and Repullo (2007) encompass both approaches by ...
Do supervisory rating standards change over time?
Supervisory BOPEC ratings were assigned to bank holding companies (BHCs) during the years 1987 to 2004 as a summary of their overall performance and level of supervisory concern. In this article, we examine the stability of the BOPEC ratings assigned over that period. We model supervisory ratings using balance sheet variables, and our analysis suggests that BOPEC rating standards varied over time. Supervisors seem to have applied more stringent rating standards from 1989 to 1992, a period marked by a recession and a large degree of distress in the banking sector. Rating standards then eased ...
Alternative measures of the Federal Reserve banks' cost of equity capital
The Monetary Control Act of 1980 requires the Federal Reserve System to provide payment services to depository institutions through the twelve Federal Reserve Banks at prices that fully reflect the costs a private-sector provider would incur, including a cost of equity capital (COE). Although Fama and French (1997) conclude that COE estimates are ?woefully? and ?unavoidably? imprecise, the Reserve Banks require such an estimate every year. We examine several COE estimates based on the Capital Asset Pricing Model (CAPM) and compare them using econometric and materiality criteria. Our results ...
Supervising interest rate risk management
This Economic Letter reviews the Basel Capital Accord's stated principles on interest rate risk. In brief, the principles strongly support the idea that banks' internal risk assessments should, whenever possible, form the basis for supervisory oversight of their interest rate risk profiles. The principles suggest supervisory guidelines for assessing the adequacy of interest rate risk management systems, such as focusing on banks' internal control functions and stress-testing results.
Evaluating credit risk models
Over the past decade, commercial banks have devoted many resources to developing internal models to better quantify their financial risks and assign economic capital. These efforts have been recognized and encouraged by bank regulators; for example, the 1997 Market Risk Amendment (MRA) formally incorporates banks' internal, value-at-risk models into regulatory capital calculations. A key component in the implementation of the MRA was the development of standards, such as for model validation, that must be satisfied in order for banks' models to be used for regulatory capital purposes. ...
Formulating the imputed cost of equity capital for priced services at Federal Reserve banks
This paper was presented at the conference "Economic Statistics: New Needs for the Twenty-First Century," cosponsored by the Federal Reserve Bank of New York, the Conference on Research in Income and Wealth, and the National Association for Business Economics, July 11, 2002. According to the 1980 Monetary Control Act, the Federal Reserve Banks must establish fees for their priced services to recover all operating costs as well as the imputed costs of capital and taxes that would be incurred by a profit-making firm. Since 2002, the Federal Reserve has made fundamental changes to the ...
The current strength of the U.S. banking sector
Using CAMELS ratings to monitor bank conditions