Regulatory capital requirements for European banks have been put forward in the Basel II Capital Framework and subsequently in the capital requirements directive (CRD) of the EU. We provide a detailed discussion of the capital requirements for private equity investments under different approaches. For the internal model approach we present a structural model that we calibrate to a proprietary dataset. We modify the standard Merton structural model to make it applicable in practice and to capture stylized facts of private equity investments. We also implement the early default feature with a fast simulation algorithm. Our results support capital requirements lower than in Basel II, but not as low as in CRD, thereby giving adverse incentives to banks for using advanced risk models. A sensitivity analysis shows that this finding is robust to parameter uncertainty and stress scenarios.

private equity, regulatory capital, risk management
Banks; Other Depository Institutions; Mortgages (jel G21), Government Policy and Regulation (jel G28), Financing Policy; Capital and Ownership Structure (jel G32)
dx.doi.org/10.1016/j.jbankfin.2008.12.015, hdl.handle.net/1765/23434
ERIM Top-Core Articles
Journal of Banking & Finance
Erasmus Research Institute of Management

Bongaerts, D.G.J, & Charlier, E. (2009). Private equity and regulatory capital. Journal of Banking & Finance, 33(7), 1211–1220. doi:10.1016/j.jbankfin.2008.12.015