Department of Economics and Business Economics

Distance to compliance portfolios: An integrated shortfall measure for Basel III

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  • Christian Schmaltz
  • ,
  • Thomas Heidorn, Frankfurt School of Finance and Management
  • ,
  • Ingo Torchiani, Deutsche Bundesbank

We propose measuring a bank's distance to compliance with Basel III using a portfolio that makes the bank compliant. This “Distance to Compliance” portfolio describes an implementable strategy and incorporates the interactions of all Basel III ratios. We derive the portfolio in a microeconomic banking model in which the board decides on the regulatory target levels and bears the responsibility in case the bank fails to meet the regulatory requirements in a stress situation. We apply our framework to two hypothetical banks and find that they achieve compliance by growth strategies without cutting lending. We corroborate that shareholders choose different compliance strategies than managers, emphasizing the importance of setting managers’ incentives carefully. We compare our results to findings from impact studies that are not model-based and do not consider the interactions of the Basel III ratios. We observe that the synergies of LCR and NSFR are the most pronounced ones but of secondary order in absolute magnitude. This means that measuring “Distance to Compliance” on a ratio-by-ratio basis omitting synergies, as often done by regulators, does not introduce a major bias.

Original languageEnglish
JournalJournal of Banking and Finance
Pages (from-to)87-101
Number of pages15
Publication statusPublished - 2018

    Research areas

  • Basel III, CAPITAL REQUIREMENTS, Impact studies, Integrated shortfall, LIQUIDITY

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