Discussion paper

DP17846 Macroprudential Regulation: A Risk Management Approach

We address the problem of regulating the size of banks' macroprudential capital buffers by using market-based estimates of systemic risk and by developing a modeling mechanism through which capital buffers can be allocated efficiently across systemic banks. First, a Distance-to-Default type measure relates a bank's default risk to its capital requirements. Second, a correlation structure in the default dependencies between banks is estimated from co-movements in the single-name CDS spreads of the underlying banks. Third, risk minimization and equalization approaches are adopted to allocate the capital requirements in line with a policy balancing the social costs and benefits of higher capital requirements. The model is applied to the European banking sector.

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Citation

Dimitrov, D and S van Wijnbergen (eds) (2023), “DP17846 Macroprudential Regulation: A Risk Management Approach”, CEPR Press Discussion Paper No. 17846. https://cepr.org/publications/dp17846