Loan pricing under Basel II in an imperfectly competitive banking market |
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| Authors: | David Ruthenberg Yoram Landskroner |
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| Institution: | aThe Banking Supervision Department, Bank of Israel, Jerusalem, Israel;bSchool of Business Administration, Hebrew University of Jerusalem, Jerusalem, Israel;cStern School of Business, New York University, USA |
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| Abstract: | The new Basel II Accord (2006), established new and revised capital requirements for banks. In this paper we analyze and estimate the possible effects of the new rules on the pricing of bank loans. We relate to the two approaches for capital requirements (internal and standardized) and distinguish between retail and corporate customers. Our loan-equation is based on a model of a banking firm facing uncertainty operating in an imperfectly competitive loan market. We use Israeli economic data and data of a leading Israeli bank. The main results indicate that high quality corporate and retail customers will enjoy a reduction in loan interest rates in (big) banks which, most probably, will adopt the IRB approach. On the other hand high risk customers will benefit by shifting to (small) banks that adopt the standardized approach. |
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| Keywords: | Basel II Minimum capital requirements Internal rating based (IRB) approach Standardized approach Probabilities of default (PD) Loss given default (LGD) Value-at-Risk (VaR) Unexpected loss (UL) Exposure at default (EAD) Retail customers Corporate customers |
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