Total loss absorption capacity – towards a simple and effective methodology
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Published
18-03-2020
Marc Sanchez-Roger
María Dolores Oliver-Alfonso
Carlos Sanchís-Pedregosa
Abstract
A successful resolution of a banking entity is linked to the level of capital and loss-absorbing debt instruments available at the time when the resolution is triggered. This article aims to propose an alternative methodology to determine the minimum requirement of loss absorption and recapitalisation capacity for banks. The model proposed uses probability of default and loss given default data together with a series of adjustment factors to estimate the necessary requirement of loss absorption capacity. One of the main advantages of this method is the simplicity and transparency of the model.
The second part of this document is focused on applying the methodology proposed to a sample of Spanish banks composed of entities with total assets above EUR200bn.
Results of the analysis point out that total loss absorption and recapitalization capacity of 27.5%-34% over risk-weighted assets is desirable. This range is above the current loss absorption requirements set by most of the international regulatory and supervisory bodies.
The results presented in this paper are meant to be especially relevant to banking regulators and supervisors, since propose an alternative methodology for calculating the loss absorption requirements.
How to Cite
Sanchez-Roger, M., Oliver-Alfonso, M. D., & Sanchís-Pedregosa, C. (2020). Total loss absorption capacity – towards a simple and effective methodology. Cuadernos De Gestión, 20(2), 199–222. https://doi.org/10.5295/cdg.180962ms
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Keywords
Bail-in, bank capital, banking resolution.
References
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Baker, M. and Wurgler, J., 2015. Do strict capital requirements raise the cost of capital? Bank regulation, capital structure, and the low-risk anomaly. American Economic Review Papers and Proceedings, 105 (5), 315–320.
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Basel Committee on Banking Supervision, 1988. International convergence of capital measurement and capital standards.
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Basel Committee on Banking Supervision, 2017. Basel III: Finalizing post-crisis reforms.
Bastos, J.A., 2010. Forecasting bank loans loss-given-default. Journal of Banking and Finance, 34 (10), 2510–2517.
Bellotti, T. and Crook, J., 2009. Loss Given Default models for UK retail credit cards. Credit Research Centre.
Biener, C., Eling, M., and Wirfs, J.H., 2015. Insurability of Cyber Risk: An Empirical Analysis. The Geneva Papers on Risk and Insurance-Issues and Practice, 147–153.
Blundell-wignall, A. and Slovik, P., 2010. The EU Stress Test and Sovereign Debt Exposures. OECD Working Papers on Finance.
Buser, S.A., Chen, A.H., and Kane, E.J., 1981. Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital. The Journal of Finance, 36 (1), 51–60.
CaixaBank, 2017. Pillar 3 - CaixaBank.
Cantieni, R., 1984. Dynamic load testing of highway bridges. Transportation Research Record.
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Chalupka, R. and Kopecsni, J.W., 2008. Modelling bank loan LGD of corporate and SME segments: A case study.
Chennells, L. and Wingfield, V., 2015. Bank failure and bail-in: an introduction. Bank of England - Quarterly Bulletin, (1), 228–241.
Cruces, J.J. and Trebesch, C., 2011. Sovereign defaults: The price of haircuts.
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Diamond, D.W. and Rajan, R.G., 2000. A theory of bank capital. The Journal of Finance EBA, 2016. Final report on MREL: Report on the implementation and design of the MREL framework.
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Van den Heuvel, S.J., 2008. The welfare cost of bank capital requirements. Journal of Monetary Economics, 55 (2), 298–320.
Ingermann, P., Christian, B., Hesse, F., and Pfingsten, A., 2013. Explaining the recovery rate for retail and commercial customers in Germany with a particular focus on the collateral.
Jacobsen, K. and Tyrell, D., 2005. Impact test of a crash-energy management passenger rail car. In: Joint Rail Conference. 1–8.
Kanaya, A. and Woo, D., 2001. The Japanese Banking crisis of the 1990s: Sources and Lessons. Essays in international economics.
Kretzschmar, G., McNeil, A.J., and Kirchner, A., 2010. Integrated models of capital adequacy - Why banks are undercapitalised. Journal of Banking and Finance, 34 (12), 2838–2850.
Kucukkocaoglu, G. and Altintas, M.A., 2016. Using Non-Performing Loan Ratios As Default Rates in the Estimation of Credit Losses and Macroeconomic Credit Risk Stress Testing: a Case From Turkey. Risk Governance and Control: Financial Markets & Institutions, 6 (1).
Lou, W., 2017. Haircutting Non-cash Collateral.
McGee, A. and Khaykin, I., 2013. Capital Assessment Stress Testing and Applications -‘Financial institution perspectives on the evolving role of enterprise-wide stress testing’.
Miu, P. and Ozdemir, B., 2006. Basel requirement of downturn LGD: modeling and estimating PD & LGD correlations. Journal of Credit Risk, 2 (November), 43–68.
Moody’s, 2016. Annual Default Study: Corporate Default and Recovery Rates, 1920-2015.
Moody’s Investor Service, I (May), 1–76.
Moody’s, 2017a. Recovery Rates Remain Within our Assumptions , Amid Weakened Repossessed Property Prices.
Moody’s, 2017b. Sovereign Default and Recovery Rates, 1983-2016 (Moody’s).
Qi, M. and Yang, X., 2007. Loss Given Default of High Loan-to-Value Residential Mortgages.
Resti, A., 2018. Review of the 2017 SREP results.
Rojas-Suarez, L. and Weisbrod, S.R., 1996. Banking Crises in Latin America: Experience and issues.
Santos, T., 2017. El Diluvio : The Spanish Banking Crisis , 2008-2012.
Schuermann, T., 2004. What Do We Know About Loss Given Default? Credit Risk Models and Management, 1–32.
Shibut, L. and Singer, R., 2014. Loss Given Default for Commercial Loans at Failed Banks.
Single Resolution Board, 2017a. Decision of the SRB on Veneto Banca.
Single Resolution Board, 2017b. Decision of the SRB on Banca Popolare di Vicenza.
Société Générale, 2017. Pillar 3 - Société Générale.
SRB, 2017. 6 th Industry Dialogue : 2017 MREL Policy.
SRB, n.d. Minimum Requirement for own funds and Eligible Liabilities (MREL)
Sturzenegger, F. and Zettelmeyer, J., 2005. Haircuts: Estimating investor losses in sovereign debt restructurings, 1998-2005. Journal of International Money and Finance.
Thorburn, K.S., 2000. Bankruptcy auctions: Costs, debt recovery, and firm survival. Journal of Financial Economics, 58 (3), 337–368.
Tröger, T.H., 2017. Why MREL Won ’ t Help Much Institute for Monetary and Financial Stability.
Vodová, P., 2003. Credit risk as a cause of banking crises.
Waemustafa, W. and Sukri, S., 2015. Bank Specific and Macroeconomics Dynamic Determinants of Credit Risk in Islamic Banks and Conventional Banks. International Journal of Economics and Financial Issues, 5 (2), 476–481.
Yan, M., Hall, M.J.B., and Turner, P., 2012. A cost-benefit analysis of Basel III: Some evidence from the UK. International Review of Financial Analysis, 25, 73–82.
Zettelmeyer, J., Trebesch, C., and Gulati, M., 2013. The Greek debt restructuring: An autopsy. Economic Policy, 28 (75), 513–563.
Zhang, Y., Ji, L., and Liu, F., 2010. Local Housing Market Cycle and Loss Given Default: Evidence from Sub-Prime Residential Mortgages. SSRN eLibrary.
Altman, E.I. and Kishore, V.M., 1996. Almost everything you wanted to know about recoveries on defauited bonds. Financial Analysts Journal, 52 (6), 57–64.
Angelini, P., Clerc, L., Cúrdia, V., Gambacorta, L., Gerali, A., Locarno, A., Motto, R., Roeger, W., Van den Heuvel, S., and Vlček, J., 2015. Basel III: Long-term impact on economic performance and fluctuations. Manchester School, 83 (2), 217–251.
Asonuma, T., Nipelt, D., and Ranciere, R., 2017. Sovereign bond prices, haircuts and maturity.
Baker, M. and Wurgler, J., 2015. Do strict capital requirements raise the cost of capital? Bank regulation, capital structure, and the low-risk anomaly. American Economic Review Papers and Proceedings, 105 (5), 315–320.
Banco Santander, 2017. Pillar 3 - Banco Santander.
Bank of England, 2017. MREL disclosure.
Bank of International Settlements, 2015. Assessing the economic costs and benefits of TLAC implementation.
Basel Committee on Banking Supervision, 1988. International convergence of capital measurement and capital standards.
Basel Committee on Banking Supervision, 2010. Basel III: A global regulatory framework for more resilient banks and banking systems.
Basel Committee on Banking Supervision, 2017. Basel III: Finalizing post-crisis reforms.
Bastos, J.A., 2010. Forecasting bank loans loss-given-default. Journal of Banking and Finance, 34 (10), 2510–2517.
Bellotti, T. and Crook, J., 2009. Loss Given Default models for UK retail credit cards. Credit Research Centre.
Biener, C., Eling, M., and Wirfs, J.H., 2015. Insurability of Cyber Risk: An Empirical Analysis. The Geneva Papers on Risk and Insurance-Issues and Practice, 147–153.
Blundell-wignall, A. and Slovik, P., 2010. The EU Stress Test and Sovereign Debt Exposures. OECD Working Papers on Finance.
Buser, S.A., Chen, A.H., and Kane, E.J., 1981. Federal Deposit Insurance, Regulatory Policy, and Optimal Bank Capital. The Journal of Finance, 36 (1), 51–60.
CaixaBank, 2017. Pillar 3 - CaixaBank.
Cantieni, R., 1984. Dynamic load testing of highway bridges. Transportation Research Record.
CEBS, 2009. CEBS Press Release on the Results of the Eu-Wide Stress Testing Exercise. CEBS.
CEBS, 2010. Aggregate outcome of the 2010 EU wide stress test exercise coordinated by CEBS in cooperation with the ECB.
Chalupka, R. and Kopecsni, J.W., 2008. Modelling bank loan LGD of corporate and SME segments: A case study.
Chennells, L. and Wingfield, V., 2015. Bank failure and bail-in: an introduction. Bank of England - Quarterly Bulletin, (1), 228–241.
Cruces, J.J. and Trebesch, C., 2011. Sovereign defaults: The price of haircuts.
Dagher, J., Dell’Ariccia, G., Laeven, L., Ratnovski, L., and Tong, H., 2016. Benefits and Costs of Bank Capital. IMF Working Paper, (March), 1–38.
Dent, K. and Westwood, B., 2016. Stress testing of banks: an introduction. Bank of England Quarterly Bulletin, 56 (3), 130–143.
Diamond, D.W. and Rajan, R.G., 2000. A theory of bank capital. The Journal of Finance EBA, 2016. Final report on MREL: Report on the implementation and design of the MREL framework.
ECB, 2011. Guidance for calculation of losses due to application of market risk parameters and sovereign haircuts.
European Banking Authority (EBA), 2014. EU - wide Stress Test 2014, (October), 1–51.
European Banking Authority (EBA), 2016. EU - wide Stress Test 2016.
European Commission, 2011. Regulation proposal on prudential requirements for credit institutions and investment firms.
European Commission, 2014. Bank Recovery and Resolution Directive (BRRD). Bank Recovery and Resolution Directive.
Financial Stability Board, 2015. Principles on Loss-absorbing and Recapitalisation Capacity of G-SIBs in Resolution.
Gambacorta, L., 2011. Do bank capital and liquidity affect real economic activity in the long run? A VECM Analysis for the US. Economic Notes, 40 (3), 75–91.
Gambacorta, L. and Mistrulli, P.E., 2004. Does bank capital affect lending behavior? Journal of Financial Intermediation, 13 (4), 436–457.
García Céspedes, J.C., 2005. Nuevas técnicas de medición del riesgo de crédito. Revista de Economía Financiera, 5, 29.
Gupton, G.M., Gates, D., and Carty, L. V., 2000. Bank loan loss given default. Moody’s Investors Service, (November 1996), 69–92.
Van den Heuvel, S.J., 2008. The welfare cost of bank capital requirements. Journal of Monetary Economics, 55 (2), 298–320.
Ingermann, P., Christian, B., Hesse, F., and Pfingsten, A., 2013. Explaining the recovery rate for retail and commercial customers in Germany with a particular focus on the collateral.
Jacobsen, K. and Tyrell, D., 2005. Impact test of a crash-energy management passenger rail car. In: Joint Rail Conference. 1–8.
Kanaya, A. and Woo, D., 2001. The Japanese Banking crisis of the 1990s: Sources and Lessons. Essays in international economics.
Kretzschmar, G., McNeil, A.J., and Kirchner, A., 2010. Integrated models of capital adequacy - Why banks are undercapitalised. Journal of Banking and Finance, 34 (12), 2838–2850.
Kucukkocaoglu, G. and Altintas, M.A., 2016. Using Non-Performing Loan Ratios As Default Rates in the Estimation of Credit Losses and Macroeconomic Credit Risk Stress Testing: a Case From Turkey. Risk Governance and Control: Financial Markets & Institutions, 6 (1).
Lou, W., 2017. Haircutting Non-cash Collateral.
McGee, A. and Khaykin, I., 2013. Capital Assessment Stress Testing and Applications -‘Financial institution perspectives on the evolving role of enterprise-wide stress testing’.
Miu, P. and Ozdemir, B., 2006. Basel requirement of downturn LGD: modeling and estimating PD & LGD correlations. Journal of Credit Risk, 2 (November), 43–68.
Moody’s, 2016. Annual Default Study: Corporate Default and Recovery Rates, 1920-2015.
Moody’s Investor Service, I (May), 1–76.
Moody’s, 2017a. Recovery Rates Remain Within our Assumptions , Amid Weakened Repossessed Property Prices.
Moody’s, 2017b. Sovereign Default and Recovery Rates, 1983-2016 (Moody’s).
Qi, M. and Yang, X., 2007. Loss Given Default of High Loan-to-Value Residential Mortgages.
Resti, A., 2018. Review of the 2017 SREP results.
Rojas-Suarez, L. and Weisbrod, S.R., 1996. Banking Crises in Latin America: Experience and issues.
Santos, T., 2017. El Diluvio : The Spanish Banking Crisis , 2008-2012.
Schuermann, T., 2004. What Do We Know About Loss Given Default? Credit Risk Models and Management, 1–32.
Shibut, L. and Singer, R., 2014. Loss Given Default for Commercial Loans at Failed Banks.
Single Resolution Board, 2017a. Decision of the SRB on Veneto Banca.
Single Resolution Board, 2017b. Decision of the SRB on Banca Popolare di Vicenza.
Société Générale, 2017. Pillar 3 - Société Générale.
SRB, 2017. 6 th Industry Dialogue : 2017 MREL Policy.
SRB, n.d. Minimum Requirement for own funds and Eligible Liabilities (MREL)
Sturzenegger, F. and Zettelmeyer, J., 2005. Haircuts: Estimating investor losses in sovereign debt restructurings, 1998-2005. Journal of International Money and Finance.
Thorburn, K.S., 2000. Bankruptcy auctions: Costs, debt recovery, and firm survival. Journal of Financial Economics, 58 (3), 337–368.
Tröger, T.H., 2017. Why MREL Won ’ t Help Much Institute for Monetary and Financial Stability.
Vodová, P., 2003. Credit risk as a cause of banking crises.
Waemustafa, W. and Sukri, S., 2015. Bank Specific and Macroeconomics Dynamic Determinants of Credit Risk in Islamic Banks and Conventional Banks. International Journal of Economics and Financial Issues, 5 (2), 476–481.
Yan, M., Hall, M.J.B., and Turner, P., 2012. A cost-benefit analysis of Basel III: Some evidence from the UK. International Review of Financial Analysis, 25, 73–82.
Zettelmeyer, J., Trebesch, C., and Gulati, M., 2013. The Greek debt restructuring: An autopsy. Economic Policy, 28 (75), 513–563.
Zhang, Y., Ji, L., and Liu, F., 2010. Local Housing Market Cycle and Loss Given Default: Evidence from Sub-Prime Residential Mortgages. SSRN eLibrary.
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