Can Loan Valuation Adjustment (LVA) Approach Immunize Collateralized Debt from Defaults?

18 Pages Posted: 5 Apr 2019

See all articles by Rafal M. Wojakowski

Rafal M. Wojakowski

University of Surrey; Lancaster University - Management School

M. Shahid Ebrahim

Durham University Business School

Aziz Jaafar

Bangor Business School

Murizah Osman Salleh

Central Bank of Malaysia

Date Written: May 2019

Abstract

This study focuses on structuring tangible asset backed loans to inhibit their endemic option to default. We adapt the pragmatic approach of a margin loan in the configuring of collateralized debt to yield a quasi‐default‐free facility. We link our practical method to the current Basel III (2017) regulatory framework. Our new concept of the Loan Valuation Adjustment (LVA) and novel method to minimize the LVA converts the risky loan into a quasi risk‐free loan and achieves value maximization for the lending financial institution. As a result, entrepreneurial activities are promoted and economic growth invigorated. Information asymmetry, costly bailouts and resulting financial fragility are reduced while depositors are endowed with a safety net equivalent to deposit insurance but without the associated moral hazard between risk‐averse lenders and borrowers.

Keywords: agency cost, collateral, financial fragility, financial innovation, financial regulation, loan default

JEL Classification: D53, G10, G20, G28

Suggested Citation

Wojakowski, Rafal M. and Ebrahim, M. Shahid and Jaafar, Aziz and Salleh, Murizah Osman, Can Loan Valuation Adjustment (LVA) Approach Immunize Collateralized Debt from Defaults? (May 2019). Financial Markets, Institutions & Instruments, Vol. 28, Issue 2, pp. 141-158, 2019, Available at SSRN: https://ssrn.com/abstract=3367149 or http://dx.doi.org/10.1111/fmii.12109

Rafal M. Wojakowski (Contact Author)

University of Surrey ( email )

Faculty of Business, Economics and Law
The Surrey Business School
Guildford, Surrey GU2 7XH
United Kingdom
+44 1483 683477 (Phone)

HOME PAGE: http://www.surrey.ac.uk/sbs/people/rafal_wojakowski/index.htm

Lancaster University - Management School ( email )

Lancaster, LA1 4YX
United Kingdom
+44 (1524) 593630 (Phone)
(01524) 847321 (Fax)

HOME PAGE: http://www.lums.lancs.ac.uk/profiles/rafal-wojakowski/

M. Shahid Ebrahim

Durham University Business School

Mill Hill Lane
Durham, DH1 3LB
United Kingdom

Aziz Jaafar

Bangor Business School ( email )

University of Wales
Bangor, LL57 2DG
United Kingdom

Murizah Osman Salleh

Central Bank of Malaysia ( email )

Jalan Dato' Onn
P.O. Box 10922
Kuala Lumpur, 50929
Malaysia

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