Basel Accords versus Solvency II – Regulatory Adequacy and Consistency under the Postcrisis Capital Standards

Over the past decade, European banking and insurance regulation has been subject to significant reforms. In this regard, one of the declared goals of the authorities is 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 objective. Our discussion begins with a detailed overview of the current standard approaches for market and credit risk. Subsequently, we describe the two new capital adequacy proposals under Basel III – the partial and fuller risk factor approach. Based on empirical data, we calibrate a realistic asset portfolio and implement the models to compare the resulting capital charges. Our findings reveal huge differences in required capital across the financial sectors for the same type of asset risk. Moreover, the critical assessment of the standard approaches ’ mechanics displays an inadequate treatment of asset classes that might lead to severe distortions in the financial institutions ’ investment decisions. In this context, the unduly promotion of government bond holdings under all three frameworks is able to further deteriorate the postcrisis issues of moral hazard in the financial industry