A Sovereign Risk-Based Approach to Implementing Countercyclical Capital Buffer Schemes

36 Pages Posted: 16 Aug 2018

See all articles by Shih-Cheng Lee

Shih-Cheng Lee

Yuan Ze University

Chien‐Ting Lin

Deakin University - School of Accounting, Economics and Finance

Minh-Phuong Doan

Deakin University - Deakin Business School

Zhisong Chen

Deakin University - Department of Finance

Date Written: August 2, 2018

Abstract

Based on the macro-financial risk framework of Gray et al. (2006) that links the balance sheets of the financial sector and public sector together through government guarantees, we propose an indicator, sovereign distance-to-default (SDD), for implementing the countercyclical capital buffer schemes of Basel III. Using a sample of 29 European countries from 1975 to 2011, we find that SDD outperforms credit-to-GDP ratio, the primary indicator recommended by the Basel Committee for Banking Supervision. More specifically, SDD generates more reliable signals for the build-up of capital buffers three years prior to a crisis and the release of capital buffers in the same year that the crisis occurs. Our findings suggest that SDD can be used as a leading indicator for the build-up phase and an anchor for the release phase of the countercyclical capital buffer schemes.

Keywords: Countercyclical Capital Buffers, Basel III, Pro-Cyclicality, Distance-to-Default, Sovereign Debt, Credit-to-GDP Ratio

JEL Classification: E44, G21, G28

Suggested Citation

Lee, Shih-Cheng and Lin, Chien‐Ting and Doan, Daisy and Chen, Zhisong, A Sovereign Risk-Based Approach to Implementing Countercyclical Capital Buffer Schemes (August 2, 2018). Available at SSRN: https://ssrn.com/abstract=3224969 or http://dx.doi.org/10.2139/ssrn.3224969

Shih-Cheng Lee

Yuan Ze University ( email )

135, Far-East Rd., Chung-Li
Taoyuan, ROC
Taiwan

Chien‐Ting Lin

Deakin University - School of Accounting, Economics and Finance ( email )

221 Burwood Highway
Burwood, Victoria 3215
Australia

Daisy Doan (Contact Author)

Deakin University - Deakin Business School ( email )

Australia

Zhisong Chen

Deakin University - Department of Finance ( email )

75 Pigdons Road
Victoria, Victoria 3216
Australia

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