Internal Rating Based Models: Do They Matter for Bank Profit Margins?
58 Pages Posted: 28 Jun 2019 Last revised: 30 Jun 2019
Date Written: June 26, 2019
The net interest margin (NIM) from the traditional intermediation function is pivotal for bank profitability and solvency. Using a unique cross-country sample on bank internal rating based (IRB) models, we find that the NIM increases when banks measure a larger share of their credit risk via IRB models. This result does not reflect greater credit risk-taking by IRB banks. Instead, IRB models improve credit risk-management, and this improvement is accompanied by lower funding costs and higher investment in interest earning assets. Ultimately, IRB models improve the risk-return trade-off of a bank’s traditional intermediation function as compared to cruder credit-risk measurement systems.
Keywords: Net-Interest Margin, Internal Risk Models, Bank Regulation
JEL Classification: G21, G28
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