Regulatory Problems of Commercial Banks in the Context of the European Sovereign Crisis
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Regulatory Problems of Commercial Banks in the Context of the European Sovereign Crisis Edward Sandoyan • Gagik Grigoryan
Published online: 8 December 2012 Springer-Verlag Wien 2012
Abstract This study aims to find whether regulatory measurement of banking risks proposed by the Basel Committee provide a framework that allows an adequate reflection of these risks in banks’ capital requirements. The analysis is carried through the prism of financial crisis that started in 2007 and current sovereign crisis in some European countries. In the study we investigated the problems attached to Standardized Approach and risk measurement of a financial instrument based on the rating of issuer. As a result we revealed contradiction in the current regulation, according to which risk free assets provide a better return than riskier assets. We found evidences of the gaps attached to Standardized Approach, which in current sovereign crisis can become problematic not only for commercial banks, but also for the issuers of financial instruments in which commercial banks have investments. Finally, we offered a different method of risk measurement that, we argue, provides a better measurement of banking risks as such. Keywords
Financial crisis Basel Sovereign crisis Banking Regulation
JEL Classifications
G01 G15 G28
Introduction The financial crisis which started in 2007 has changed the stereotypes and perception which previously existed for the commercial banks. Basel I and Basel II, E. Sandoyan G. Grigoryan (&) Finance, Monetary Circulation and Credit Department, Russian-Armenian Slavonic University, Yerevan, Armenia e-mail: [email protected] E. Sandoyan e-mail: [email protected]
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which were regulating international banking system starting from 1988, were unable to overcome problems that rose as a result of this financial crisis. It was not merely a financial crisis, it became the first global crisis of regulatory system. The reason we call it regulatory crisis is because many banks which met the requirements of Basel II, and which had acceptable capital adequacy ratio, announced bankruptcy (Cullen 2011). The list of such banks included Northern Rock, Merrill Lynch, etc. As a consequence, it became obvious that business risks were not properly addressed by the existing regulation. The aim of the research is to identify whether regulatory measurement of banking risks according to Basel II Standardized Approach provides a framework that allows an adequate reflection of these risks in banks’ capital requirements. In order to achieve our aim we will test the following hypotheses: 1.
2. 3.
Risk weights assigned to an asset according to Basel II Standardized Approach, contradicts risk-return correlation (according to the latter, between assets with an equal profitability, an investor will chose less risky asset), Assets, including sovereign assets, cannot be risk free, Rating of an issuer of a financial instrument does not fully and timely reveal all the informatio
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