Working Paper | 2001

Bank Capital and Risk Management: Issues for Banks and Regulators

by Kenneth A. Froot

Abstract

Banks and financial firms are in the process of evolving away from primary warehousers of risk to diversified originators and distributors of financial services. These changes are important for the way that financial firms think about their needs for economic capital and capacity to bear risk. They are also important for the way regulators evaluate capital and connect it to concepts of systemic and liquidity risk.

This essay tries to grapple with the implications of such changes. I argue that the BIS standards place important, but perhaps excessive, emphasis on risks that emerge from financial contracts that warehouse risk and pay insufficient attention to non-warehouse business risks that emerge from broader bank activities. I also argue that the profitability of non-warehouse businesses alters economic capital requirements and necessitates changes in standard VaR calculations, and that non-warehouse businesses create important externalities in regulating systemic and liquidity risks. I believe that the Basel Committee's proposals, while providing a significant move forward, lag behind these developments in financial firm activities and may lead to considerable regulatory distortions as a result.

Keywords: bank capital and risk management; issues for banks and regulators; Risk Management; Governance Compliance; Capital; Banks and Banking; Banking Industry;

Citation:

Froot, Kenneth A. "Bank Capital and Risk Management: Issues for Banks and Regulators." IFCI Geneva Research Paper, No. 8, April 2001. (International Financial Risk Institute.)