A MARKET EVALUATION OF THE RISK-BASED CAPITAL STANDARDS FOR THE US FINANCIAL-SYSTEM

This paper evaluates U.S. risk-based capital guidelines by comparing stock market measures of institutions' risk with current regulatory risk-based capital measures. The first part of the evaluation compares overall market and regulatory risk-based capital measures of current capital adequacy, required capital, and the capital infusion required to meet the capital requirement. The second part compares regulatory risk weights on individual risk categories with market-determined risk weights. The results suggest that the market and risk-based capital standards agree to some extent on the adequacy of institutions' current capital and required capital infusion, but that their measures of asset risk are not positively correlated. Further, the 100 percent risk category for banks and the 50 and 200 percent categories for S&Ls do distinguish activities that are riskier by market measures. However, the market model makes limited distinctions among the other categories. In addition, the results suggest that some off-balance sheet activities for banks may reduce asset risk.