COMPARISON OF CAPITAL REQUIREMENTS DEFINED BY INTERNAL (VAR) MODEL AND STANDARDIZED METHOD

Abstract

The activities and different assets of commercial banks, investment funds and other financial institutions involve many risks, which have an effect on their profitability. One of the most important risks is called market risk, which is in connection with interest rate risk and price risk of held shares, bonds and derivatives. These effects have an impact as great as anywhere else for Hungarian financial institutions. The Trading Book prescribes the capital charge against risky positions. It requires that the owners´ equity must be sufficient to cover the calculated requirement. The Trading Book permits two alternatives (based on the recommendation of the Basle Committee) for financial institutions, defining the measurement method of market risk and the necessary capital charges against it. They can choose a statistical and mathematical approach called the Internal Model to define the capital requirement. The alternative is the Standardized Method which could be developed by an institution rather than the Internal Method. In this article I compare these two alternatives and I argue to confirm that firms would be expected to choose the Standardized Methods in Hungary defining capital charges even though the other method applies superior tools and could explain the riskiness of a portfolio.