B0273
Title: On CRDIV and banks' simultaneous defaults
Authors: Francesca Di Girolamo - European Commission Joint Research Centre (Italy)
Andrea Pagano - European Commission-Joint Research Centre-IPSC Financial and Economic Analysis Unit (Italy)
Marco Petracco - Joint Research Centre of the European Commission (Italy) [presenting]
Abstract: The Capital Requirement Directive IV issues rules on the new regulatory standards for bank capital adequacy. Among others, it requires all instruments in the additional Tier 1 layer of a credit institution to be written down or converted into equity, as soon as the CET1 falls below 5.125\% of risk weighted assets. Whether or not the new framework is making the banking sector more resilient, there is still one issue that regulators have never dealt with. What the Basel accord imposes to each bank is a minimum capital meant to cover unexpected losses as the banks were isolated entities. In reality, banks are exposed to common borrowers. A quantitative assessment of the effect of having a commonality among banking shocks is performed. The banks are supposed to be interconnected via a correlation and contagion structure and a micro simulation model is used to estimate the joint distribution of losses. Results show that the correlation increases systemic losses up to 5\% or to 40\% when adding second round effects. A series of rules are defined to annihilate the losses due to the commonality. The analysis provides evidence that the regulatory rule of requiring extra capital as soon as the CET1 falls down the 5.125\% of risk weighted assets is more efficient than asking GSIBs or all banks to increase their capital, and may thus be an efficient macroeconomic tool to face banks' simultaneous defaults and help in dealing with the missing piece of the Basel framework.
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