Basel releases framework for assessing systemic risk of large banks

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BASEL - The Basel Committee on Banking Supervision has published a new paper proposing a framework for measuring and stress testing the systemic risk posed by a group of major financial institutions.

The paper measures systemic risk by the price of insurance against financial distress, based on before-the-event measures of default probabilities of individual banks and forecasted asset return correlations.

It says it is important to use realised correlations estimated from high-frequency equity return data to improve the accuracy of forecasted correlations.

Basel Committee stress-testing methodology, using an integrated micro-macro model, looks at the dynamic linkages between the health of major US banks and macro-financial conditions.

The theoretical insurance premium suggested by the framework that would be charged to protect against losses that equal or exceed 15% of total liabilities of 12 major US financial firms was $110 billion in March 2008, up to a possible high of $250 billion in July 2008.

The paper can be read here.

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