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Reliable estimation of capital requirement for banking sector using peak over threshold approach

F. Badaoui, A. Amar, C. G. Okou, A. Zoglat, S. El Adlouni

Abstract



One of the key lessons of the last financial crisis has been the need to strengthen the risk coverage of the capital framework. The formulas, suggested by the Basel Committee, to calculate capital requirements are inappropriate when data are obviously not normally distributed. Applying these formulas to such data could lead to catastrophic consequences of incorrect risk evaluations. This paper shows how the peaks over threshold approach, a widely used technique to describe the exceedances, can be used to get a reliable estimation of capital requirements. A numerical example shows that this approach estimates are
more accurate than the Basel ones. Moreover, it is shown that the used techniques can be extended to predict the near economic future state. This kind of predictions is of prime importance for improving the banking sector’s ability to absorb shocks arising from financial and economic stress, thus reducing the risk of spillover from the financial sector to the real economy.

Keywords


Extreme Values Theory, Capital Requirement, Peaks Over Threshold, Probability of Default, Generalized Pareto Distribution, Likelihood Ratio Test.

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