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Regulatory Capital Charges for Too‐Connected‐to‐Fail Institutions: A Practical Proposal
Author(s) -
ChanLau Jorge A.
Publication year - 2010
Publication title -
financial markets, institutions and instruments
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.386
H-Index - 23
eISSN - 1468-0416
pISSN - 0963-8008
DOI - 10.1111/j.1468-0416.2010.00161.x
Subject(s) - solvency , financial institution , incentive , position (finance) , capital requirement , systemic risk , business , institution , financial crisis , capital (architecture) , economics , finance , financial system , microeconomics , political science , history , archaeology , market liquidity , law , macroeconomics
The recent financial crisis has highlighted once more that interconnectedness in the financial system is a major source of systemic risk. I suggest a practical way to levy regulatory capital charges based on the degree of interconnectedness among financial institutions. Namely, the charges are based on the institution's incremental contribution to systemic risk based on a risk budgeting approach. The imposition of such capital charges could go a long way towards internalizing the negative externalities associated with too‐connected‐to‐fail institutions and providing managerial incentives to strengthen an institution's solvency position, and avoid too much homogeneity and excessive reliance on the same counterparties in the financial industry.