The IRB model, bank regulatory arbitrage, and the Eurozone crisis

摘要

By using a novel dataset on bank-level exposures to specific countries, I investigate how model-based capital regulations can be misused by European banks for capital saving purposes during the Eurozone sovereign debt crisis. I find that relative to banks from core countries, banks from peripheral countries (1) could greatly reduce the risk-weight of their assets in capital requirement calculations by applying more model-based capital rules, and (2) that the default frequency of their assets is not properly reflected in their capital requirement calculations. These results indicate that banks from peripheral countries are more likely to conduct regulatory arbitrage against model-based capital rules. (c) 2021 Elsevier Ltd. All rights reserved.In order to increase the stability of the financial system, policymakers have been improving the regulatory framework, with particular attention given to the design of bank's capital charge. In this regard, the most important innovation is model-based capital regulation, which was introduced around the new millennium. Regulations under Basel II allow banks to choose between two different approaches to assess the credit risk associated with their assets and to evaluate capital adequacy, namely the IRB approach and the standardised approach (SA). Specifically, the IRB approach enables banks to design and calibrate their own risk models, subject to approval from the supervisors. Thus, it ties the capital charge to the actual risk associated with specific assets. Regulators believe that capital requirements based on such an approach can be more sensitive to the drivers of risk, and that an appropriately structured framework can motivate banks to improve their internal risk management (BCBS 2001). Cucinelli et al (2018) also provide some empirical evidence that banks apply the IRB approach were able to curb the increase in credit risk due to macro economy better than banks stick to the standardized approach. However, critics point out that complex and opaque rules can create high compliance costs and barriers to entry (BCBS