Daniela Laas

Basel III versus Solvency II: An Analysis of Regulatory Consistency under the New Capital Standards

Over the past decade, European banking and insurance regulation has been subject to significant reforms. One of the declared goals of the authorities was the enhancement of market stability through adequate and consistent capital standards. This paper provides a critical analysis of the Basel II, III, and Solvency II capital standards for asset risks in light of this regulatory objective. Our discussion begins with a detailed overview of the current standard approaches for market and credit risk. Furthermore, we describe the two new capital adequacy proposals under Basel III – the partial and fuller risk factor approach. Based on a theoretical analysis and a numerical comparison of the capital charges, our paper reveals an inaccurate treatment of risk categories and severe inconsistencies between the capital standards for banks and insurers. While the latter could lead to an exploitation of regulatory arbitrage opportunities across industries, the former might result in severe distortions to the financial institutions’ investment decisions. The unduly promotion of government bond holdings under all three frameworks is able to further deteriorate the postcrisis issue of moral hazard in the financial industry.

Basel III Versus Solvency II: An Analysis of Regulatory Consistency Under the New Capital Standards: Basel III Versus Solvency II

This article provides a critical analysis of the consistency of the standard approaches for market and credit risks under Solvency II and the current and forthcoming Basel III standards. The comparability is assessed both theoretically via a detailed comparison of the capital standards and in a numerical analysis that contrasts the capital charges for a stylized portfolio. Our examination reveals substantial discrepancies in the design of the frameworks. These lead to vastly differing capital requirements for the same risks. Moreover, the analysis indicates higher charges for banks than insurers, especially under the proposed new Basel III standard approaches.