FDIC Center for Financial Research Working Paper No. 2004-02. Capital Adequacy and Basel II

摘要

Using a one common factor Black-Scholes-Merton (BSM) equilibrium model of credit risk, this paper derives unbiased capital allocation rules for portfolios in which idiosyncratic risk is fully diversified. When these rules are compared with the Basel II Internal Ratings Based (IRB) minimum capital requirements for corporate exposures, the comparison shows that the Basel Advanced IRB (A-IRB) approach drastically undercapitalizes portfolio credit risk relative to the supervisory target of a 99.9 percent bank solvency rate. Estimates show that Basel regulations will allow fully compliant A-IRB banks to have default rates that exceed 5 percent. In contrast, the Foundation IRB minimum capital requirements allocate multiple times the capital necessary to achieve the supervisory objective. These results raise a number of important issues including the potential for increased systemic risk as regulatory capital rules promote banking sector consolidation and poor risk management standards in A-IRB banks.