BIS Paper Explores Enhanced G-SIB Capital Surcharge Framework

This paper describes four improvements to the current implementation of the BCBS expected impact framework. In this paper, the authors introduce a theoretically sound and an empirically grounded approach to estimating a probability of default (PD) function and apply density-based cluster analysis to identify the reference bank for each G-SIB indicator. They also recalibrate the systemic loss-given-default (LGD) function that determines G-SIB scores, using both the current system based on supervisory judgment and using an alternative system based on CoVaR, to finally derive a continuous capital surcharge function to determine G-SIB capital surcharges.

The authors find that these empirically-based alternative implementations of the expected impact framework would result in minor declines in G-SIB surcharges in the aggregate, but would result in the removal of some of the smaller G-SIBs from the list of G-SIBs. Adopting the "supervisory" surcharge function, which is calibrated to maintain the general level of capital surcharges based on the current supervisory consensus, would result in changes of less than 30 bps in individual G-SIB scores, and in moderate changes in G-SIB surcharges. Adopting a surcharge function that uses CoVaR as a measure of LGD would result in both more significant increases in capital and more significant declines in G-SIB scores and surcharges. These findings suggest that these functions could be used to monitor current G-SIB surcharges, particularly by highlighting gains from the cap on the substitutability score and from cliff effects.

The approach presented in this paper would strengthen the empirical and theoretical foundation of the G-SIB surcharge framework. Moreover, the continuous surcharge function would reduce banks' incentive to manage their balance sheets to reduce systemic capital surcharges, mitigate cliff effects, allow for the lifting of the cap on the substitutability score and penalize growth in the category for all G-SIBs. In addition, the two capital surcharge functions might be used to monitor G-SIBs' capital adequacy and distortions induced by G-SIB surcharges.

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Keywords: International, Banking, G-SIBs, Systemic Risk, G-SIB Surcharge, Loss Given Default, Regulatory Capital, Basel, BIS