Industries : SWFs, Pension Funds, Banking Financial Service, Insurance Reinsurance & Brokerage ]

RsRL’s question to BIS and other regulatory bodies is: Are present risk measures and capital requirements adequate?

The truth here is that we still do not know. They may be, but we will only know about inadequacy if they are breached. Short of 100% reserves this is the best we can do. The scary thing is the concept of “adequate” capital requirements. If people think such a thing exists then they are simply deluding themselves. “Adequacy” here is a relative concept. Even 100% reserves. depends from leverage. Leverage 15/20 times and even 100% does not make you safe. The risk measure that is in use in the financial industry is Value-at-Risk or VaR. Mathematically speaking this is a quantile at accepted failure level (say 0.1% or 0.5%). The required capital is then calculated in order to have a failure probability lower than the VaR-level. No concern of what happens below that level. This is the same as given a free option to the company. To put it in an extreme way: in case one goes bankrupt, make sure it is a very big bankruptcy. The lower you might get, the higher one can come with the expected benefit. Positive parts and negative parts are in equilibrium. Some have created VaR-like measures which integrate the Tail (or the square of the Tail, etc.) to distinguish the cases as you note. This does give more information, and even can buy one out of the failure at subadditivity. There is a limit, however, to the information content of a single point (or two or three points) on the real line. A complete function (like a distribution function) provides infinitely (literally) more information.