The Impact of the IRB Approach on the Relationship Between the Cost of Credit for Public Companies and Financial Market Conditions

45 Pages Posted: 25 Aug 2020

See all articles by Raffaele Gallo

Raffaele Gallo

Bank of Italy - Research Department

Date Written: July 28, 2020

Abstract

This paper examines whether the regulatory approach adopted by banks to calculate capital requirements has a different impact on the loan rates for public and private companies when financial market conditions change. Using Italian data for the period 2008-18, the analysis documents that the adoption of the internal ratings-based (IRB) approach has led to a significantly greater sensitivity of the loan rates applied to public companies to financial market conditions, proxied by the VSTOXX index. For credit granted by IRB banks, being public is associated with a significant loan cost advantage when the level of financial instability is low. However, when VSTOXX rises, public companies experience a greater increase in loan rates than private firms; the effect is determined mostly by less capitalized IRB banks. In contrast, for credit granted by banks that adopt the standardized approach (SA), public borrowers do not benefit from a significant loan cost advantage compared with private ones, and a change in financial market conditions has a similar impact on loan rates for both types of companies.

Keywords: credit risk regulation, public firm, financial stability, interest rates, bank credit

JEL Classification: G01, G20, G21, G32

Suggested Citation

Gallo, Raffaele, The Impact of the IRB Approach on the Relationship Between the Cost of Credit for Public Companies and Financial Market Conditions (July 28, 2020). Bank of Italy Temi di Discussione (Working Paper) No. 1290, Available at SSRN: https://ssrn.com/abstract=3680593 or http://dx.doi.org/10.2139/ssrn.3680593

Raffaele Gallo (Contact Author)

Bank of Italy - Research Department ( email )

Via Nazionale 91
00184 Roma
Italy

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