The Method Of Economic Capital Measurement For Commercial Banks And Its Application

With the process of finance globalization and liberalization, the industry of international banking is faced with an increasing number of risk types and higher level of risk, and the stability of the banking system is under serious threat. Accordingly, the focus of bank's management has become from the traditional asset-liability management to integrated risk management. The philosophy of Bank's management has also taken place in two fundamental changes: First, banks have attached more importance to their own value creation, and have become aware that only the pursuit of proceeds or just emphasise of risk will not realize the goal of maximizing shareholder value; Second, banks are becoming increasingly aware that how to allocate and use capital efficiently has become a new topic of bank's capital management. Capital management, capital adequacy ratio and capital return of commercial banks have become the core of the operation and management of commercial banks.In order to manage bank's capital better, the sector of international banking brought forward the concept of economic capital. Economic Capital is also known as Risk Capital, which is put forward in the developed financial markets and in the reality of more risk, and is a different concept from regulatory capital. Regulatory capital is external constraints from the regulatory authorities, but economic capital is based on the bank's own internal estimates of risk. The amount of capital must be assigned to different product in accordance with certain criteria, which reflects the pursuit of gains and the principle of risk-sharing for capital. The measurement of economic capital is on the basis of the risk profile of bank assets and bank's risk appetite, and to determine the overall bank capital levels banks should be held, or the amount of capital consumed by a particular sector or product.In this paper, I took economic capital measurement and its application as the main research object, and studied in the following aspects:(1) I put forward three methods of the overall economic capital measurement of commercial banks by combining value at risk and option pricing. They are economic capital measurement with completely deposit insurance, with partly deposit insurance, and with no deposit insurance. All these methods all reflect the risk and yield of bank's asset. I Not only gave the derivation of these methods , and compared the size of them , but also analysed the relationship between economic capital and the yield of bank assets, asset volatility and bank's objective probability of payment. I also estimated the economic capital ratio of the listed banks in China by using the economic capital measurement with no deposit insurance and with completely deposit insurance.(2)I studied appropriateness of regulatory capital on the basis of overall economic capital measurement.I set up two parameters—the regulatory capital ratio and the statutory minimum regulatory capital ratio, which can be compared to the economic capital ratio. I also used descriptive statistical methods, parameters and non-parametric statistical methods to separately compare economic capital ratio with regulatory capital ratio and minimum regulatory capital ratios.Through the empirical analysis of 14 listed banks in China, We found that the regulatory capitals held by the listed banks were on average still not sufficient to resist the actual risk although they met the requirements of legal minimal regulatory capital.(3)I set up a new deposit insurance pricing method on the basis of total economic capital with partly deposit insurance by combining the options pricing method and expected loss method, and gave the estimated methods and calculation steps. The empirical studies proved the feasibility and rationality of the method. My method can not only describe the influence of holding capital and quality of the banks' asset on the deposit insurance pricing, but also reflected the impact of the commercial bank's debt discharge order in bankruptcy and the proportion of the insured deposit on the risk-based premium of deposit insurance.(4)I set up a method to measure economic capital of credit portfolio on the basis of ASRF model, which is able to integrate the credit risk and market risk. This method can comprehensively characterize all the impact of interest rate risk, credit spread risk, credit migration risk and credit default risk on the measurement of economic capital, and give a specific formula of economic capital. The simulation result shows that the economic capital taking into account of interest rate risk and credit spread risk is more than the economic capital with only credit default and shifting risk.(5)I brought forward two methods of loan pricing based on credit risk economic capital measurement. One method is a model of credit risk economic capital measure and loan pricing based on the asymptotic single risk factor model, which is able to depict the effect of the system risk factor on the loss given default. The numerical example proved that this model improved the accuracy and risk sensitivity of loan pricing and economic capital. Due to the net income buffer to the credit risk, we also set up a loan pricing and economic capital measure model including the net interest correction. The amount of economic capital including net interest correction reflects the risk preference of commercial banker correctly, and reduces the loan pricing. The second model through the assumption that the yield to maturity of the asset is related to economic capital is a model of economic capital measurement and loan pricing based on the Gaussian credit return model. It can describe the impact of default probability of borrower, the loss rate given default, risk preferences of (target pay probability) of commercial banks ,and the financing costs of capital on economic capital measurement and loaning pricing, and will be helpful to the related decision-making of commercial banks.The main innovation points of this thesis:(1) I put forward three methods of the overall economic capital measurement of commercial banks by combining value at risk and option pricing.They are economic capital measurement with completely deposit insurance, with partly deposit insurance, and with no deposit insurance. The three methods all reflect the amount of capital hold by banks in order to guarantee payment under given confidence level. The result will help to improve the rationality of the decision of risk management and capital structure of banks.(2) I firstly empirically studied the moderateness of regulatory capital hold by commercial banks in China based on total economic capital measure.This paper first empirically studies the moderateness of regulatory capital hold by commercial banks in China. This paper has two main different points compared with existing literatures:(1) I brought forward a method to direct measure the real level of bank's asset risk, not to anti-calculate the capital level by using the deposit insurance rate. (2) It is innovative to judge the moderateness of regulatory capital through comparing the capital bank should hold with the capital level banks really hold by using parametric and non- parametric statistical methods.(3) I brought forward a method on deposit insurance pricing based on total economic capital measure with partly deposit insurance. This article set up a new deposit insurance pricing method on the basis of the options pricing method and expected loss method, and gave the estimated methods and calculation steps. Our method can not only describe the influence of holding capital and quality of the banks' asset on the deposit insurance pricing, but also reflect the impact of the commercial bank's debt discharge order in bankruptcy and the proportion of the insured deposit on the risk-based premium of deposit insurance.(4) I set up a method to measure economic capital of banks' asset which is able to integrate credit risk and market risk in the framework of ASRF model.I gave a formula of economic capital measure which integrates interest rate risk, credit spread risk, credit transfer risk and credit default risk. The principles of economic capital measurement is consistent with the total economic capital measurement, that is, from a financing point of view, it gave the the smallest capital level in one unit of bank assets in order to guarantee banks to cover its liabilities in given probability.(5) I set up two methods to measure economic capital and prize loan.One method is a model of credit risk economic capital measure and loan pricing based on the asymptotic single risk factor model, which is able to depict the effect of the system risk factor on the loss given default. The numerical example proves that this model improves the accuracy and risk sensitivity of loan pricing and economic capital. Due to the net income buffer to the credit risk, we also set up a loan pricing and economic capital measure model including the net interest correction. The amount of economic capital including net interest correction reflects the risk preference of commercial banker correctly, and reduces the loan pricing.The second model through the assumption that the yield to maturity of the asset is related to economic capital set up a model of economic capital measurement and loan pricing based on the Gaussian Credit Return Model. It can describe the impact of default probability of borrower, the loss rate given default, risk preferences of (target pay probability) of commercial banks, the financing costs of capital on economic capital measurement and loaning pricing, and will be helpful to the related decision-making of commercial banks.