The Handbook of Credit Risk Management, 2nd Edition

CHAPTER 15Regulation

We have explained how financial institutions calculate the economic capital they need to support their credit operations and described their primary goals as meeting self‐imposed solvency requirements and also measuring and optimizing the profitability of their business. In this chapter, we survey how regulation affects credit risk management practices and in particular what regulators require of financial institutions as minimal amounts of capital. This is known as regulatory capital, and its size is influenced by a number of parameters, including the content of the credit portfolio.

Governments and their agencies around the world regulate financial institutions to ensure the safety and soundness of the financial system, which protects consumers, businesses, and economies overall. In particular, regulators provide considerable oversight to those firms that take funds from individuals with the promise to repay or make these funds available on demand or at a later time. This includes depository financial institutions (such as commercial banks, credit unions, and thrifts), insurance companies, and securities brokers, among others. The mission of financial regulation ranges from keeping financial systems safe and sound by instilling confidence in the financial system and ensuring solvency of financial institutions, to leveling the playing field for investors, to preventing fraud, and to promoting ethical market practices. Regulations for banks, insurers, and ...