CHAPTER
6
Risk Capital Aggregation
So far we have discussed how different risk types, such as market, credit, operational,
and business risks, can be measured. Yet in order to support top-management decisions
concerning capital management and capital allocation, an integrated picture of risks is
needed. The challenge of risk aggregation, i.e., the development of quantitative risk mea-
sures, such as an aggregated estimate of economic capital, incorporating multiple types
or sources of risk (see Joint Forum 2003) across different business units, is therefore
particularly important.
Risk aggregation and the size of diversifi cation benefi ts that might result from being
exposed to different risks in different businesses are relevant both from a regulatory and
from the individual bank’s point of view, even if we focus mainly on the bank’s perspec-
tive. The debate about the extent of diversifi cation benefi ts that can be achieved by running
different activities in the fi nancial sector has been a topic of discussion in the past during
the debate concerning whether restrictions on U.S. bank activity should be abolished by
adopting a universal banking approach as in European countries (see Saunders and Walter
1993). In this context, a number of empirical studies were conducted in order to under-
stand whether “nonbank” activities could reduce overall risk for bank holding companies
(for a survey, see Brewer, Fortier, and Pavel 1988). At present, the regulatory debate is
related to whether and how diversi cation benefi ts among businesses or risks can and
should be taken into account in setting minimum capital requirements (see Kuritzkes,
Schuermann, and Weiner 2001, 2002; Joint Forum 2003).
However, apart from minimum regulatory capital requirements, understanding how
risk could be aggregated and, consequently, the size of diversi cation benefi ts is extremely
important from the point of view of bank decision making in an economic capital perspec-
tive. Risk aggregation is important for capital management, since it can enable the risk
manager to give top managers a measure of the overall capital needed to run the bank
145

Get Value at Risk and Bank Capital Management now with O’Reilly online learning.

O’Reilly members experience live online training, plus books, videos, and digital content from 200+ publishers.