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Basel III, does one size fit all? : The implications of Basel III for different banking business models

Wiersma, M. (2019) Basel III, does one size fit all? : The implications of Basel III for different banking business models.

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Abstract:The new Basel III regulation, which came in place after the recent financial crisis, limits the scope of banking activities (Mergaerts and Vander Vennet, 2016). It moves from allowing banks to use internal risk models to a one-size-fits-all approach (Ayadi, Arbak, and De Groen, 2012; Ayadi et al., 2016). However, a multi-dimensional view on the effects of this approach on systemic diversity and the risk-return performance of different banking business models is missing. Therefore, the goal of our research is to get a deeper understanding of the performance of different banking business models under the new restrictions of Basel III. To obtain this understanding, we have built a model that predicts business model risk-return performance and investigates improvement directions, while considering the requirements of Basel III. The three banking business models that are investigated are the retail, wholesale and investment business models. The model transform the average balance sheet composition of the three banking business models over time according to the macro-financial scenario of the EBA 2018 EU-wide stress test. The average balance sheet compositions of these business models will be determined by using three samples of banks with the same business model. To create distinct samples for each business model, the business models of banks are classified according to our own developed business-model-score methodology, which is derived from the statistical clustering results of Ayadi et al. (2016). Additionally, we will perform a sensitivity analysis to determine the optimal improvement direction. Combining the findings of our research, leads to confirmation of earlier conclusions that including more retail products on the balance sheet will make individual banks more resilient in times of stress. However, if this occurs on a large scale this might reduce systemic diversity and therefore increase systemic risk. We found that migrations towards activities other than retail activities can be (even more) feasible from both the risk and return perspective. The optimal migration direction is different for every bank and is dependent on a bank’s maturity profile, counterparty credit rating profile and its business-typical-activities. This opposes the neoclassical assumption that firms can optimize uniformly across a sector and indicates that one size might not fit all. Therefore, we recommend regulators to further investigate the acknowledgement, followed by the inclusion, of systemic diversity and banking business models in banking regulation. A first concrete step to realise this could be to make banking business models a regulatory concept.
Item Type:Essay (Master)
Zanders, Bussum, Netherlands
Faculty:BMS: Behavioural, Management and Social Sciences
Subject:31 mathematics, 83 economics
Programme:Industrial Engineering and Management MSc (60029)
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