Loan pricing under Basel capital requirements

We analyze the loan pricing implications of the reform of bank capital regulation known as Basel II. We consider a perfectly competitive market for business loans where, as in the model underlying the internal ratings based (IRB) approach of Basel II, a single risk factor explains the correlation in defaults across firms. Our loan pricing equation implies that low risk firms will achieve reductions in their loan rates by borrowing from banks adopting the IRB approach, while high risk firms will avoid increases in their loan rates by borrowing from banks that adopt the less risk-sensitive standardized approach of Basel II. We also show that only a very high social cost of bank failure might justify the proposed IRB capital charges, partly because the net interest income from performing loans is not counted as a buffer against credit losses. A net interest income correction for IRB capital requirements is proposed.     

A Critique of Revised Basel II

This paper critiques the revised Basel II capital requirements for banks. To provide a framework for analysis, the XYZ theory of regulatory capital is formulated. Independent of the XYZ theory, we argue that the revised Basel II capital rule for credit risk is not a good approximation to the ideal rule. Based on this, and using the XYZ theory, we argue that: (1) the revised Basel II rules should not replace the existing approaches for determining minimal capital standards, but should be used in conjunction with them, and (2) that calibrating the capital rules to maintain aggregate market capital is a prudent procedure.     

资本计量方法改革、商业银行风险偏好与信贷配置

为提高银行业风险管理水平与信贷配置效率,监管部门于2014年开展了资本管理高级方法的试点工作。本文基于上市银行2010至2016年的微观数据,与银监会公布的行业信贷风险进行匹配,采用双重差分和三重差分法,实证分析前述改革如何影响试点银行的风险偏好和信贷调配。研究发现,在资本管理高级方法实施后:(1)试点银行显著降低了风险加权资产的规模;(2)试点银行风险偏好的变化存在非线性的特征,在调减高风险行业贷款的同时,并未显著增加最安全行业的贷款,而是增加了风险略高行业的贷款,体现出试点银行对风险与收益的权衡;(3)进一步将行业划分为“虚”与“实”,研究发现试点银行减少了房地产业(“虚”)、制造业(“实”)和建筑业(“实”)贷款,显著增加了金融业(“虚”)贷款。本文研究不仅丰富了资本监管方面的文献,也对金融支持供给侧结构性改革具有启示意义。     

Capital requirements under the credit risk-based framework

This work aims to study the hypothesis of lower capitalization of banks under the risk-based rules introduced in Basel II. In this sense, an assessment of the impact of these rules on the capital requirements for non-financial firms’ credit risk is performed. A comparison with Basel I is presented and intervals of variation for the risk drivers such that capital requirements exceed the ones under Basel I are established. Data for a European country supports the hypothesis of a smaller capitalization of banks under the risk-based framework, as far as credit risk in concerned.     

An Assessment of Basel II Procyclicality in Mortgage Portfolios

In this paper we develop a probability of default (PD) model for mortgage loans, taking advantage of the Spanish Credit Register, a comprehensive database on loan characteristics and credit quality. From that model, we calculate different types of PDs: point in time, PIT, through the cycle, TTC, average across the cycle and acyclical. Then, we compare capital requirements coming from the different Basel II approaches. We show that minimum regulatory capital under Basel II can be very sensitive to the risk measurement methodology employed. Thus, the procyclicality of regulatory capital requirements under Basel II is an open question, depending on the way internal rating systems are implemented and their output is utilised. We focus on the mortgage portfolio since it is one of the most under researched areas regarding the impact of Basel II and because it is one of the most important of banks’ portfolios.     

Competitive effects of Basel II on US bank credit card lending

We analyze the potential competitive effects of the proposed Basel II capital regulations on US bank credit card lending. We find that bank issuers operating under Basel II will face higher regulatory capital minimums than Basel I banks, with differences due to the way the two regulations treat reserves and gain-on-sale of securitized assets. During periods of normal economic conditions, this is not likely to have a competitive effect; however, during periods of substantial stress in credit card portfolios, Basel II banks could face a significant competitive disadvantage relative to Basel I banks and nonbank issuers.     

A practical approach to validating a PD model

The capital adequacy framework Basel II aims to promote the adoption of stronger risk management practices by the banking industry. The implementation makes validation of credit risk models more important. Lenders therefore need a validation methodology to convince their supervisors that their credit scoring models are performing well. In this paper we take up the challenge to propose and implement a simple validation methodology that can be used by banks to validate their credit risk modelling exercise. We will contextualise the proposed methodology by applying it to a default model of mortgage loans of a commercial bank in the Netherlands.     

Potential Competitive Effects of Basel II on Banks in SME Credit Markets in the United States

We examine the likely competitive effects of implementation of Basel II capital requirements on banks in the market for credit to SMEs in the U.S. Similar competitive effects from Basel II may occur for other credits and financial instruments in the U.S. and other nations. We address whether reduced risk weights for SME credits extended by large banking organizations that adopt the Advanced Internal Ratings-Based (A-IRB) approach of Basel II might significantly adversely affect the competitive positions of other organizations. The analyses suggest only relatively minor competitive effects on most community banks because the large A-IRB adopters tend to make very different types of SME loans to different types of borrowers than community banks. However, there may be significant adverse effects on the competitive positions of large non-A-IRB banking organizations because the data do not suggest any strong segmentation in SME credit markets among large organizations. JEL classification: G21, G28, G38, L51     

Basel II: Correlation Related Issues

Basel II aims to aggressively improve on Basel I, and is projected to capitalize on the technological advancements that have permeated the financial industry since Basel I. This paper examines the correlation issues that arise, and provides recommendations on implementation as we move forward. We provide the following results: (1) We demonstrate that fixing asset value correlations by regulators without a specification of business unit granularity and aggregation impacts franchise risk. (2) Loss distributions for credit risk are more sensitive to correlation assumptions that those for market risk; arbitrary, inaccurate correlation specifications can cause large errors in capital requirements. (3) Current regulations do not recognize that credit losses depend on four distinct correlations, not just one. (4) Recovery rates may be determined uniformly across banks. (5) Tail risk comes from LGD correlations and non-Gaussian risks. (6) The 1-year VaR horizon causes distortions especially when regimes and pro-cyclicality are involved. (7) We recommend a quantitative measure for implementing market discipline, the third pillar of the Basel II accord. Therefore, this paper highlights many issues that may be addressed using the tools banks already employ for internal risk management.     

Loan pricing under Basel II in an imperfectly competitive banking market

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.     

Risk-based capital requirements for mortgage loans

We contribute to the debate over the reform of the Basel Accord by developing risk-based capital requirements for mortgage loans held in portfolio by financial intermediaries. Our approach employs simulation of both economic variables that affect default incidence and conditional loss probability distributions. Results indicate that appropriate capital charges for credit risk vary substantially with loan characteristics and portfolio geographic diversification. Hence, rules that offer little risk differentiation, including the current Basel I regime and “standardized” approach proposed in Basel II result in significant divergence between regulatory and economic capital. These results highlight the incentive problems inherent in simplified methods of capital regulation.     

Financial stability and Basel II

The Basel II Advanced Internal Ratings (AIRB) approach is compared to capital requirements set using an equilibrium structural credit risk model. Analysis shows the AIRB approach undercapitalizes credit risk relative to regulatory targets and allows wide variation in capital requirements for a given exposure owing to ambiguity in the definitions of loss given default and exposure at default. In contrast, the Foundation Internal Ratings Based (FIRB) approach may over-capitalize credit risk relative to supervisory objectives. It is unclear how Basel II will buttress financial sector stability as it specifies the weakest regulatory capital standard for large complex AIRB banks.      

A real options approach for evaluating the implementation of a risk-sensitive capital rule in banks

I evaluate a bank's incentives to implement a risk-sensitive regulatory capital rule. The decision making is analyzed within a real options framework where optimal policies are derived in terms of threshold levels of credit risk. I provide a numerical example for the implementation of internal ratings based models for credit risk (the IRB approach) under the new Basel Accord (Basel II).     

Basel II vs. Prompt Corrective Action: Which Is Best for Public Policy?

This paper evaluates Basel II as a tool for achieving public policy objectives relative to structured early intervention and resolution (SEIR) and prompt corrective action (PCA) in the U.S. It concludes that Basel II compares poorly in terms of maintaining a safe and sound banking system. Rather, Basel II resembles a "best practices" guide for banks in managing their credit risk. However, it may do damage through encouraging some large banks in the U.S. to successfully pressure their regulators to lower the capital trigger ratio for "adequately‐capitalized" status in order to benefit from any lower regulatory capital requirement that Basel II may give them.     

Modelling the economic value of credit rating systems

In this paper we develop a model of the economic value of credit rating systems. Increasing international competition and changes in the regulatory framework driven by the Basel Committee on Banking Supervision (Basel II) called forth incentives for banks to improve their credit rating systems. An improvement of the statistical power of a rating system decreases the potential effects of adverse selection, and, combined with meeting several qualitative standards, decreases the amount of regulatory capital requirements. As a consequence, many banks have to make investment decisions where they have to consider the costs and the potential benefits of improving their rating systems. In our model the quality of a rating system depends on several parameters such as the accuracy of forecasting individual default probabilities and the rating class structure. We measure effects of adverse selection in a competitive one-period framework by parameterizing customer elasticity. Capital requirements are obtained by applying the current framework released by the Basel Committee on Banking Supervision. Results of a numerical analysis indicate that improving a rating system with low accuracy to medium accuracy can increase the annual rate of return on a portfolio by 30–40 bp. This effect is even stronger for banks operating in markets with high customer elasticity and high loss rates. Compared to the estimated implementation costs banks could have a strong incentive to invest in their rating systems. The potential of reduced capital requirements on the portfolio return is rather weak compared to the effect of adverse selection.     

Credit Risk Versus Capital Requirements under Basel II: Are SME Loans and Retail Credit Really Different?

Under Basel II, retail and SME credit (R&SME) receive special treatment because of a supposedly smaller exposure to systemic risk. Most research on this issue has been based on parameterized credit risk models. We present new evidence by applying Carey's (Carey, Mark. “Credit Risk in Private Debt Portfolios.” Journal of Finance 53, no. 4 (1998), 1363–1387.) nonparametric Monte-Carlo resampling method to two banks' complete loan portfolios. By exploiting that a sub-sample of all borrowers has been assigned an internal rating by both banks, we can compare the credit loss distributions for the three credit types, and compute both economic and regulatory capital under Basel II. We also test if our conclusions are sensitive to the definitions of R&SME credit. Our findings show that R&SME portfolios are usually riskier than corporate credit. Special treatment under Basel II is thus not justified. JEL classification: C14, C15, G21, G28, G33.     

Credit risk in the leasing industry

This paper is devoted to the credit risk modeling issues of retail lease portfolios. Using a re-sampling method, I estimate the probability density function of losses and VaR measures in a portfolio of 46,732 leases issued between 1990 and 2000 by a major European financial institution. My results show that physical collaterals play a major role in reducing the credit risk associated with lease portfolios. However, because of insufficient recognition of such collaterals under the new regulatory capital framework (Basel II), significant differences are observed between the estimated capital requirements and those calculated in accordance with the various Basel II approaches.     

Procyclicality: The Macroeconomic Impact of Risk-Based Capital Requirements

Recent research on the Basel II capital framework suggests that binding capital requirements may be responsible for bank behaviour which causes procyclical amplifications of the macroeconomic cycle. This paper presents a model of the interrelations between the state of the economy, credit risk, and loan supply to clarify and quantify this effect. Special attention is paid to the fact that both regulatory and economic capital requirements can significantly influence loan supply, provided that they are binding. The model shows that both economic capital, based on a one-factor model, and the regulatory IRB requirements cause more procyclicality than the constant regulatory requirements of the Basel I capital accord. However, the overall impact depends on the interrelation of the regulatory requirements with economic capital. Based on this result, the replacement of the Basel I requirements with risk-sensitive IRB capital requirements boosts procyclicality under most, but not under all conditions.     

The Effect of Bank Ownership Concentration on Capital Adequacy,Liquidity, and Capital Stability

We explore the effects of ownership concentration on the risk-taking behavior of banks. Our analysis focuses on East Asian countries because these nations have successfully implemented the Basel standards and demonstrate a high degree of regulatory convergence. For the period from 2005 to 2009, we analyzed the relation between ownership concentration and capital adequacy (Basel II) and find that an increase in ownership concentration by one standard deviation results in an improvement in capital adequacy by 7.64 %. Although Basel III does not go into effect until 2013, we retroactively apply the standards for capital stability on our sample. We find that ownership concentration would have been a significant determinant of capital stability. While at lower levels of ownership concentration, an increase in concentrated ownership would have reduced capital stability; at higher ownership levels, greater ownership concentration would have increased capital stability. We also find that concentrated ownership improves banks’ liquidity. Further, the recent financial crisis does not appear to change the fundamental associations among ownership concentration, capital adequacy, and liquidity.     

巴塞尔新资本协议下的项目融资贷款信用评级方法研究

项目融资是巴塞尔新资本协议作为专项贷款监管的资产类别,具有有限追索的特点,具有广阔的市场前景,银行在对该类贷款进行贷款决策、贷款定价和资本配置时都涉及信用评级的问题,但国内银行业缺少对这类贷款进行信用评级的经验和方法.针对这一现状,本文首先分析了银行在项目融资贷款中面临的风险,建立了包括财务风险、项目信用结构风险等五个方面的信用评级指标体系,然后运用层次分析法和模糊综合评价法对项目融资贷款项目中的风险进行客观的评价,建立了和新资本协议监管标准的映射关系,为项目融资类贷款的定价和决策提供了具体、可行的依据.