Do additional capital requirements for G-SIBs and O-SIIs reflect bank riskiness?

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Volume Title

School of Business | Master's thesis

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Date

2024

Department

Rahoituksen laitos

Major/Subject

Mcode

Degree programme

Finance

Language

en

Pages

70

Series

Abstract

After the Great Financial Crisis, more emphasis in bank regulation was placed on addressing systemic risk and interconnectedness. Classification of Global Systemically Important Banks (G-SIBs) and Other Systemically Important Institutions (O-SIIs) led to the creation of frameworks which assign additional capital requirements to designated institutions to decrease the likelihood of bank failures and public sector interventions. The frameworks assign capital buffers based on systemic importance measures (e.g. size and interconnectedness), however not explicitly differentiating banks based on business model differences or their riskiness. We conduct research on whether there is a connection between the level of these current additional capital requirements and the riskiness of a bank using a multiple regression model. We study whether a riskier bank (measured by net income volatility, Z-score, cost of risk, and Tier 1 capital ratio as risk indicators) has a higher capital requirement than a lower-risk bank. We find, in line with our hypothesis, that the riskiness of a bank is not reflected in the level of the additional capital requirements for G-SIBs and O-SIIs. This means that in terms of additional G-SIB and O-SII capital buffers, from a risk perspective, low-risk banks may be over-regulated whereas high-risk banks may be under-regulated. We propose a new constructive scoring criteria for G-SIBs and O-SIIs, introducing a sixth scoring category, bank risk, which is based on the risk indicators of the regression model. With this new proposed scoring criteria, we illustrate changes that would happen in G-SIB and O-SII scores if the riskiness of the bank was accounted for. We find that this leads to increases in systemic importance scores (and level of capital requirements) especially for banks with high risk indicator scores and decreases in scores for banks which might be otherwise systemically important, but are operating a relatively stable and low-risk business model. The proposed scoring methodology would have increased G-SIB scores by approximately 9 percent on average in 2022. The changes in O-SII scores would have varied from -14 percent to +16 percent in 2022. Our research expands on the existing literature questioning whether the current “one-size-fits-all” approach for setting capital requirements for significant institutions is adequate. We conclude based on previous academic literature that it would be economically meaningful to set bank capital requirements thoughtfully also from a risk perspective and consequently propose an alternate framework for scoring and accounting for the riskiness of the bank.

Description

Thesis advisor

Puttonen, Vesa

Keywords

G-SIB, O-SII, capital requirements, bank riskiness, bank regulation, bank business model

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Permanent link to this item

https://urn.fi/URN:NBN:fi:aalto-202406234783

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[gradu] Kauppakorkeakoulu / BIZ