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| Author: | Peura, S. Jokivuolle, E. |
| Title: | Simulation based stress tests of banks' regulatory capital adequacy |
| Journal: | Journal of Banking and Finance
2004 : AUG, VOL 28:8, p. 1801-1824 |
| Index terms: | Banking Capital Regulations |
| Language: | eng |
| Abstract: | Banks' holding of reasonable capital buffers in excess of minimum requirements could alleviate the procyclicality problem potentially exacerbated by the rating-sensitive capital charges of Basel II. This paper presents a simulation-based approach to stress testing of regulatory capital (hereafter as: reg-cap.) adequacy (here as: aqy.) where rating transitions are conditioned on business-cycle (here as: b-c.) phase, and which takes into account b-c. dynamics. This paper's approach is an extension of a typical credit portfolio analysis. Actual bank capital is driven by bank income and default losses, whereas capital requirements within Basel II are driven by rating transitions. The joint dynamics of these determine the necessary capital buffers, given a confidence level for reg-cap. aqy. chosen by bank management. |
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