Banking Risk Management And Supervision Under The Procyclicality

Like the Great Depression in the 1930s bringing the terms of "Liquidity Trap" and "Government Intervention" into controversy, the most serious financial crisis since the Great Depression that broke out in the first decade of this century, contributes to the development of economics and leaves the world a precious legacy by drawing attention on "Procyclicality" and " Macro-prudential Regulation". In this financial turmoil partly characterized by the bankruptcy of investment banks, the New Basel Capital Accord, which is the regulatory standard of international banking and has just entered into force, because of the timing is no doubt in the center of controversy and even became a financial crisis scapegoat. Based on this background, this paper follows the economics principles of procyclicality, discusses the widespread procyclicality existing in the regulatory framework of banking operations under the new Basel Capital Accord and its factors, proposes ways to mitigate the procyclicality from the standpoint of banking practice as well as measures to prevent the procyclicality from the viewpoint of banking supervisors and monetary policy-makers respectively.In the discussion on the factors causing bank procyclicality, based on the framework of the New Basel Capital Accord, the paper analyzes and diagnoses the factors from the perspective of capital regulation, the internal rating-based approach in the new accord and the accuracy of risk measurement and accounting measurement. Under capital regulation represented by the Basel Capital Accord, the procyclicality of capital will lead to the procyclicality of the behavior of bank credit, which directly affects investment demand under capital restriction, thereby causing procyclicality in the fluctuations of the economy. The internal rating-based approach, which is one of the major improvements in the New Basel Capital Accord, brings along the risk of bank procyclicality while enhancing risk sensitivity. In a market with extensive development of asset securitization, the procyclicality caused by the point-in-time rating method also tend to be magnified. The defects in traditional risk measurement models and the improper uses of the models cause the inaccurate measure of risk during economic recession. Moreover, the accounting accelerator effect caused by the failure of fair value accounting standard during the period of short market liquidity accelerates the procyclicality in the economic system. On account of the three factors mentioned above that cause bank procyclicality, this paper discusses current plausible measures of mitigation respectively. For capital regulation, the paper proposes the countercyclical adjustment programs of dynamic capital adequacy ratio and dynamic provisioning and analyzes the feasibility of improving the current regulation on capital adequacy ratio from the viewpoint of adding leverage ratio supervision and mortgage rates supervision. In addition, the paper discusses the decrease of banks'reluctance to lend, caused by the preferred shares capitalization, from the perspective of bank operation, and analyzes how to release the procyclicality in bank operation from a more macro view of exchange rate. For the release of the procyclicality caused by internal rating-based approach, the paper adopts the standpoint of IRB function parameters and weight function and concludes that the major way to release the procyclicality caused by internal rating-based approach is to introduce parameters measuring economic cycle and improve the single risk weight function, and substituting through-the-cycle measurement for point-in-time measurement would help smooth the fluctuations in economic cycle. For risk measurement, the paper introduces stress testing and the method of stressed VaR as a forceful complement to traditional VaR approach. For accounting standard, based on amendments to post-crisis accounting standards, the paper discusses the directions for the fair value measurement,For bank supervisors, it is impossible to be alert of bank procyclicality and implement micro-prudential supervision alone by the Basel Capital Accord. They need to implement a more comprehensive and macro-prudential risk supervision. This paper discusses applicable tools and guidelines for procyclicality supervision based on summarizing and inducing the latest ideas and methods by international banking regulatory institutions on macro-prudential supervision and cross-border banking supervision.As for monetary policy-makers, different from the regulatory objective of bank regulators for banking risk, they are more concerned about the effects of monetary policy and the overall development of macroeconomic. This paper extends the procyclicality model under capital supervision to a broader framework containing the factor of monetary policy, analyzes the significance of implementing dynamic capital adequacy ratio from the perspective of monetary policy effect, and examines the optimal monetary policy strategy under capital supervision procyclicality from the standpoint of the dual objectives of managing inflation and boosting economic growth.Based on the framework described above, this paper summarizes the factors affecting bank procyclicality and proposes approaches to release the procyclicality. It also analyzes how to cope with bank procyclicality from the viewpoint of bank regulators and monetary policy-makers. The conclusions bring forward the problems that need to be solves in the future and the directions of research.