Prudential Filters, Portfolio Composition and Capital Ratios in European Banks

41 Pages Posted: 8 Jan 2016

See all articles by Isabel Argimón

Isabel Argimón

Banco de España

Ángel Estrada

Banco de España

Michel Dietsch

Institut d'Etudes Politiques

Date Written: January 7, 2016

Abstract

European banks hold 10% of their total assets in portfolios that give rise to unrealised gains and losses which under Basel III will no longer be allowed to be removed from banks’ regulatory capital. Using a sample of European banks, and taking advantage of the different treatment afforded, under Basel II, to such gains and losses among jurisdictions and instruments and over time, we find evidence that: a) the inclusion of unrealised gains and losses in capital ratios increases their volatility; b) the partial inclusion of unrealised gains and total inclusion of losses on fixed-income securities in regulatory capital, compared with the complete exclusion of both (neutralisation), reduces the volume of securities categorised as Available For Sale (AFS), thus potentially affecting liquidity management and demand for bonds (most of which are currently government bonds); and c) the higher the partial inclusion of gains from debt instruments, the lower the holdings of such instruments in the AFS category and the higher the regulatory Tier 1 capital ratio, thus affecting banks’ capital buffer strategy. We do not find evidence that the removal of neutralisation would impact capital ratios.

Keywords: prudential regulation, regulatory capital, fair value accounting, prudential filters

JEL Classification: G21, M41

Suggested Citation

Argimón, Isabel and Estrada, Ángel and Dietsch, Michel, Prudential Filters, Portfolio Composition and Capital Ratios in European Banks (January 7, 2016). Banco de Espana Working Paper No. 1538, Available at SSRN: https://ssrn.com/abstract=2712204 or http://dx.doi.org/10.2139/ssrn.2712204

Isabel Argimón (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

HOME PAGE: http://www.bde.es

Ángel Estrada

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

HOME PAGE: http://www.bde.es/

Michel Dietsch

Institut d'Etudes Politiques

27 rue Saint-Guillaume
Paris Cedex 07, 75337
France

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