Risk Management and Value Creation in ... - Arabictrader.com

Capital Structure in Banks 209
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Be exposed to the same fundamental and similar business risks with
the same volatility 355 and diversification benefits from the mix of
activities
Have the same certain solvency standard (or one needs to adjust for
it)
Be exposed to a minimum of market and credit risk or must have the
same (stable) credit rating history
Have the same “fixed” cost base
Be present in same geographical areas
All of these assumptions make it very difficult to find appropriately
comparable companies. Nonetheless, the results of this benchmarking exercise
can be useful for checking the results of the historical accounting-based
approach and the Monte Carlo simulation approach.
If business risk capital is not determined at the aggregate bank level but
rather at the business unit level, for aggregating the results, one also needs
to consider the benefits of diversification when calculating the overall required
capital amount. In order to calculate these diversification benefits,
we need to estimate a correlation matrix that produces the overall bankwide
business capital figure, when applied to the business units’ capital figures.
However, the difficulty lies both with determining the correlations and
in how the overall capital amount is then allocated back to the single business
units.
In practice, the overall amount of business risk capital is allocated back
to the business units as a percentage of their fixed costs base (mostly as a
percentage of noninterest expenses) because, as we have seen, fixed costs
tend to be the most predictive driver of business risk capital. Even though
this approach ignores the fact that some percentage of the variable costs are
also considered to be fixed when deriving the capital amount, it has the
advantage of giving incentive to the business unit managers to reduce (overall)
costs or to move to a more variable cost structure.
Problems with the Quantification of Operational Risk Even though “pure” statistics
is less powerful for measuring operating risk 356 than for measuring credit
and market risk, the “Basle II proposal” (beyond focusing on credit risk)
for the first time calls for explicit (regulatory) capital requirements for
event risks. 357 This means that the new regulatory framework will be com-
355 The analogue company must have the same mix of activities. Only some business
lines, such as asset management or data processing, have directly comparable analogues
in the market.
356 For a similar line of reasoning, see Stulz (2000), pp. 4-15–4-16.
357 Also, for the first time, interest rate risk in the banking book is subject to regulatory
requirements.