Home / Research / Cluster 2 / Theme 1

Challenges of European banking, capital regulation
and real estate business:
improving policies and risk management

Contact University of Deusto for this project

Mikel Larreina
Professor of Finance Management
University of Deusto
Faculty of Economics and Business Administration ┐ La Comercial
48007- Bilbao - Spain
Phone: +34 94 4139260
Fax: +34 94 4457381

Contact Tilburg University for this project

Frans de Roon
Professor of Finance (Investments)
Faculty of Economics & Business Administration
Tilburg University
Phone: +31 13 466 8229
Fax: +31 13 466 2875

Contact Bocconi University for this project

Andrea Sironi
Full Professor of Banking and Finance
Department of Finance
Bocconi University
Viale Isonzo 25, 20135 Milan, Italy

University of Deusto

The importance of the theme in present developments in Europe and the world is undeniable. There is a team of 10 people coordinated by Prof. Fernando Bezares which has a solid record of work and research in the field. The team has met and discussed at length cooperation with RISE on these issues and Dr. Larreina was nominated to be the coordinating person for the task. The academic group is also working with specialists and researchers in these issues at the BBVA (Bilbao Vizcaya Argentaria Bank). They are also related to a laboratory for simulation and modelling.

They have been dealing with the different issues related to financial markets. They have particularly dealt with financial institutions and instruments and have done work on the improvement of modelling financial returns and return distribution. Another aspect they have been working on is performance in the indexes and asset pricing. They are now moving towards issues of risk management.

The connections of UD Financial Department and, in deed of the two Business Faculties of UD with both the International Banks of BBVA and Santander are really strong. A number of academics are advisers to these banks at the highest level and carry out research for them and a number of their top directors belong to the Governing Boards of the new Deusto Business School. This offers a high possibility for research cooperation in this area. There is also strong links with the Saving Banks (3) in the area and this could be a significant area for cooperation.

The suggestion from the group is that Dr Lareina gets in touch with the Tilburg team to explore possibilities of joint research on view of the issues which are being developed in each of the universities together with their financial surroundings to create joint perspectives.

Tilburg University

Financial markets and institutions allow individuals and organizations to manage and insure many types of (financial) risks, examples of which are interest rate risk, commodity price risk and the risks related to many types of asset classes such as stocks, bonds and real estate. These financial institutions, such as banks, have in turn to face and manage many risks themselves. Instruments to value and manage risk in many assets and liabilities have improved, leading to a better understanding of the risk allocation and risk sharing characteristics of financial markets and institutions. Also, recent research has resulted in improved modelling of financial returns and insights in return distributions. These instruments and insights facilitate decision making on efficient and equitable institutional arrangements.

However, individuals as well as organizations also face risks that are difficult to manage and hedge, as the markets for trading these risks are either incomplete or non-existent. Examples are inflation risk, and risk related real estate. Institutional arrangements determine to which extent these are shared within and between banks and with other players in financial markets. Given the long-term nature of many of these risks, it is crucial to have a proper understanding of long-term investments and the associated risk and return characteristics.

As there is an increased consolidation in the banking sector, there are fewer possibilities for risk sharing between banks This demands a more important role of other financial institutions and financial markets to manage risks. At the same time, (financial) institutions are continuously looking for new asset classes, outside stock and bond markets, where especially investing in real estate, including for instance infrastructure projects, are becoming more and more attractive. As investments in real estate are typically very illiquid, their risk and return characteristics are not very well understood and yield a new type of risks for financial institutions. In addition to the fact that real estate is an illiquid investment class, it may require active involvement in its management that is not common in stock and bond investments.

Important research areas where advances can be expected in the coming years should first of all focus on the role that financial markets and institutions can play in relation to these developments: consolidation in the banking industry and illiquid investments in for instance real estate, that are currently not (actively) traded in financial markets. Many research and policy questions follow from these types of issues. How, for example, should financial contracts, products, and institutions be designed? How should the risk of illiquid investments in real estate be modelled and what new types of risk do they have? What type of risk management is needed for real estate investments? How should real estate be valued if there are no (recent) market prices available, and how should companies report on this?

A second research area is the regulatory environment. Here, the issues to be addressed are further insights into regulatory environments and their consequences, but also the optimal design of regulation. On the one hand, a changing landscape in the banking industry may require a different type of regulation and more transparency, on the other hand, illiquid investments in for instance real estate are by nature less transparent than investments in stock and bond markets, and may also require different types of regulation and reporting.

Relevance to future of European societies
As the European landscape of the financial industry, in particular banking, is changing rapidly, the issues mentioned above are highly relevant. Also, investments in real estate (and other illiquid investment classes) poses new challenges to banks and other financial industries. Proper risk management is crucial for this industry, as poor risk management may have significant effects on many individual┐s wealth.

Bocconi University

During the last twenty years a significant amount of resources have been invested, both at the public authorities level and in the private sector, to better understand and measure the different types of risks faced by large financial institutions. These efforts have been aimed at two main purposes. First, to improve the risk management systems internally designed and implemented by major financial institutions. Second, to improve the supervisory policies adopted by regulatory agencies. These efforts have mostly led to the development of a risk management system centred around risk measures such as value at risk and expected shortfall and to a system of risk based capital requirements that has recently become effective with the so-called Basel 2 framework.

Despite these progresses, a number or relevant research questions are still open. Some of these questions became especially relevant as a consequence of the recent financial crisis originated by the U.S. subprime crisis. These open issues concern both risk management as an internal activity within banks and other financial institutions and the design of the optimal regulatory and supervisory policies to be adopted. Here is just brief list of some of the most relevant open research questions:
- How can the different types of risks faced by major financial institutions (market risk, credit risk, interest rate risk, liquidity risk, etc.) be integrated in an effective and accurate way?
- How can concentration risk be properly measured and integrated within the capital adequacy framework via Pillar 2 of Basel 2?
- How correlated are default rates, recovery rates and exposures at default in the context of credit risk?
- How much can banks and other financial institutions┐ supervisory authorities rely on market discipline to effectively contain the risk taken by them?
- How can liquidity risk be measured and eventually integrated into the supervisory system of banks?

These questions are addressed at the research level through a multidisciplinary approach combining finance, statistics, economics, etc.

Relevance to future of European societies
The research themes briefly described above are clearly relevant for the future of the European society. Indeed, a well designed and effective banking regulatory framework would significantly improve the development and growth and development of the real economy by preventing episodes of banking crisis that would likely have negative effects in the availability of credit for the economy. More generally, a well functioning financial system would improve the channelling funds from surplus to deficit units and, at the same time, it would improve the efficient allocation of financial resources to those investment projects that possess the better return to risk profile and are therefore more promising for the growth of the real European economy.

University of Mannheim

We are particularly interested to participate in projects on the following topics:
- Real estate finance and real estate investment markets
- Linkages between real estate investment markets and asset markets for equities and bonds
- International financial market integration
- Asset pricing for equity markets, test of new asset pricing models (e.g. conditional and time-varying models)
- Pricing of hybrid instruments and other financial instruments with embedded options
- Event studies (including the development and application of new estimation and testing procedures for long-term event studies)
- Explanation of market expectations
- Developments in the markets for venture capital and private equity
- Socially responsible investments and corporate social responsibility (link to Theme 3: Sustainability in corporate decision-making)
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