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Capital Adequacy Tests and Limited Liability of Financial Institutions


Moreno, Santiago; Koch-Medina, Pablo; Munari, Cosimo-Andrea (2014). Capital Adequacy Tests and Limited Liability of Financial Institutions. Swiss Finance Institute Research Paper 14-03, University of Zurich.

Abstract

The theory of acceptance sets and their associated risk measures plays a key role in the design of capital adequacy tests. The objective of this paper is to investigate, in the context of bounded financial positions, the class of surplus-invariant acceptance sets. These are characterized by the fact that acceptability does not depend on the positive part, or surplus, of a capital position. We argue that surplus invariance is a reasonable requirement from a regulatory perspective, because it focuses on the interests of liability holders of a financial institution. We provide a dual characterization of surplus-invariant, convex acceptance sets, and show that the combination of surplus invariance and coherence leads to a narrow range of capital adequacy tests, essentially limited to scenario-based tests. Finally, we emphasize the advantages of dealing with surplus-invariant acceptance sets as the primary object rather than directly with risk measures, such as loss-based and excess-invariant risk measures, which have been recently studied by Cont, Deguest & He and by Staum, respectively.

Abstract

The theory of acceptance sets and their associated risk measures plays a key role in the design of capital adequacy tests. The objective of this paper is to investigate, in the context of bounded financial positions, the class of surplus-invariant acceptance sets. These are characterized by the fact that acceptability does not depend on the positive part, or surplus, of a capital position. We argue that surplus invariance is a reasonable requirement from a regulatory perspective, because it focuses on the interests of liability holders of a financial institution. We provide a dual characterization of surplus-invariant, convex acceptance sets, and show that the combination of surplus invariance and coherence leads to a narrow range of capital adequacy tests, essentially limited to scenario-based tests. Finally, we emphasize the advantages of dealing with surplus-invariant acceptance sets as the primary object rather than directly with risk measures, such as loss-based and excess-invariant risk measures, which have been recently studied by Cont, Deguest & He and by Staum, respectively.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2014
Deposited On:18 Jun 2014 13:34
Last Modified:19 Jul 2018 06:26
Series Name:Swiss Finance Institute Research Paper
OA Status:Green
Free access at:Official URL. An embargo period may apply.
Official URL:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2348590
Other Identification Number:merlin-id:9228

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