Are Banks' Internal Risk Parameters Consistent? Evidence from Syndicated Loans

37 Pages Posted: 6 Dec 2013

See all articles by Simon Firestone

Simon Firestone

Freddie Mac - Housing Analysis and Research

Marcelo Rezende

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2013

Abstract

This paper examines consistency in the estimates of probability of default (PD) and loss given default (LGD) that nine large U.S. banks assign to syndicated loans for regulatory capital purposes. Using internal bank data on loans that had PDs and LGDs assigned by more than one bank, we find substantial dispersion in these parameters. Banks differ substantially in PDs, but only a few set PDs systematically higher or lower than the median bank. However, many banks differ from the median bank systematically in LGDs, and these differences affect their Basel II minimum regulatory capital significantly. The differences in LGDs imply that, for an identical loan portfolio, the bank that sets the highest LGDs would have Basel II minimum regulatory capital twice as large as the bank that sets the lowest LGDs. We argue that these differences in risk parameters across banks can be at least partially explained by bank behavior that complies with the Basel rules. We also find a negative re lation between banks' LGDs and their shares in loan syndicates, suggesting that differences in risk parameters have implications beyond bank capital.

Keywords: Probability of default, loss given default, bank capital

JEL Classification: G21, G28

Suggested Citation

Firestone, Simon and Rezende, Marcelo, Are Banks' Internal Risk Parameters Consistent? Evidence from Syndicated Loans (October 1, 2013). FEDS Working Paper No. 2013-84, Available at SSRN: https://ssrn.com/abstract=2363667 or http://dx.doi.org/10.2139/ssrn.2363667

Simon Firestone

Freddie Mac - Housing Analysis and Research ( email )

Mailstop A96
8250 Jones Branch Drive
McLean, VA 22102
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Marcelo Rezende (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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