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Title: Macroprudential capital requirements and systemic risk
Authors: Lehar, Alfred
Gauthier, Celine
Souissi, Moez
Keywords: Risk Management
Issue Date: 2010
Citation: C. Gauthier, A. Lehar, and M. Souissi, “Macroprudential Capital Requirements and Systemic Risk,” working paper, Ottawa, Bank of Canada, 2009
Abstract: In the aftermath of the financial crisis, there is interest in reforming bank regulation such that capital requirements are more closely linked to a bank’s contribution to the overall risk of the financial system. In our paper we compare alternative mechanisms for allocating the overall risk of a banking system to its member banks. Overall risk is estimated using a model that explicitly incorporates contagion externalities present in the financial system. We have access to a unique data set of the Canadian banking system, which includes individual banks’ risk exposures as well as detailed information on interbank linkages including OTC derivatives. We find that macroprudential capital allocations can differ by as much as 50% from observed capital levels and are not trivially related to bank size or individual bank default probability. Macroprudential capital allocation mechanisms reduce default probabilities of individual banks as well as the probability of a systemic crisis by about 25%. Our results suggest that financial stability can be enhanced substantially by implementing a systemic perspective on bank regulation.
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