Downturn Credit Portfolio Risk, Regulatory Capital and Prudential Incentives

International Review of Finance, Vol. 10, No. 2, 2010, pp. 185-207

36 Pages Posted: 10 Nov 2013

See all articles by Daniel Roesch

Daniel Roesch

University of Regensburg

Harald (Harry) Scheule

University of Technology Sydney (UTS) - School of Finance and Economics; Financial Research Network

Date Written: November 26, 2009

Abstract

This paper analyzes the level and cyclicality of bank capital requirement in relation to (i) the model methodologies through-the-cycle and point-in-time, (ii) four distinct downturn loss rate given default concepts, and (iii) US corporate and mortgage loans. The major finding is that less accurate models may lead to a lower bank capital requirement for real estate loans. In other words, the current capital regulations may not support the development of credit portfolio risk measurement models as these would lead to higher capital requirements and hence lower lending volumes. The finding explains why risk measurement techniques in real estate lending may be less developed than in other credit risk instruments. In addition, various policy recommendations for prudential regulators are made.

Keywords: Basel II, Business Cycle, Capital Adequacy, Correlation, Credit Portfolio Risk, Credit Value-at-Risk, Economic Downturn, Expected Loss, Loss Given Default, Probability of Default, Value-at-Risk

JEL Classification: G20, G28, C51

Suggested Citation

Roesch, Daniel and Scheule, Harald, Downturn Credit Portfolio Risk, Regulatory Capital and Prudential Incentives (November 26, 2009). International Review of Finance, Vol. 10, No. 2, 2010, pp. 185-207, Available at SSRN: https://ssrn.com/abstract=2351381

Daniel Roesch (Contact Author)

University of Regensburg ( email )

Chair of Statistics and Risk Management
Faculty of Business, Economics and BIS
Regensburg, 93040
Germany

HOME PAGE: http://www-risk.ur.de/

Harald Scheule

University of Technology Sydney (UTS) - School of Finance and Economics ( email )

P.O. Box 123
Broadway, NSW 2007
Australia

HOME PAGE: http://https://www.uts.edu.au/staff/harald.scheule

Financial Research Network ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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