Proposal on ELBE and LGD In-Default: Tackling Capital Requirements after the Financial Crisis

27 Pages Posted: 28 Jun 2018

Date Written: June 25, 2018

Abstract

Following the financial crisis, the share of non-performing loans has significantly increased, while the regulatory guidelines on the Internal-Ratings Based (IRB) approach for capital adequacy calculation related to defaulted exposures remains too general. As a result, the high-risk nature of these portfolios is clearly in danger of being managed in a heterogeneous and inappropriate manner by those financial institutions permitted to use the IRB system, with the consequent undue variability of Risk-Weighted Assets (RWA). This paper presents a proposal to construct Advanced IRB models for defaulted exposures, in line with current regulations, that preserve the risk sensitivity of capital requirements. To do so, both parameters Expected Loss Best Estimate (ELBE) and Loss Given Default (LGD) in-default are obtained, backed by an innovative indicator (Mixed Adjustment Indicator) that is introduced to ensure an appropriate estimation of expected and unexpected losses. The methodology presented has low complexity and is easily applied to the databases commonly used at these institutions, as illustrated by two examples.

Keywords: Credit risk, Defaulted exposures, Banking regulation

JEL Classification: C51, G21, G28, G32

Suggested Citation

Ramos González, Marta and Partal-Ureña, Antonio and Gómez-Fernández-Aguado, Pilar, Proposal on ELBE and LGD In-Default: Tackling Capital Requirements after the Financial Crisis (June 25, 2018). ECB Working Paper No. 2165, Available at SSRN: https://ssrn.com/abstract=3202618 or http://dx.doi.org/10.2139/ssrn.3202618

Marta Ramos González (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Antonio Partal-Ureña

University of Jaén ( email )

23071 Jaen
Spain

Pilar Gómez-Fernández-Aguado

University of Jaén ( email )

23071 Jaen
Spain

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