Credit Ratings and the Standardized Approach to Credit Risk in Basel Ii
47 Pages Posted: 12 Sep 2005
Date Written: July 25, 2005
Abstract
This paper focuses on the standardized approach to credit risk in Basel II. The minimum capital requirements for the corporate, interbank and sovereign loan portfolios of a representative bank in each EMU country are evaluated by means of Monte-Carlo simulations depending on the credit rating agencies chosen by the bank to risk-weight its exposures. Three main results emerge from the analysis. First, although the use of different combinations of credit rating agencies leads to significant differences in minimum capital requirements, these differences never exceed 10% of banks' regulatory capital for loans to corporates, banks and sovereigns on average in the EMU. Second, the standardized approach provides a small regulatory capital incentive for banks to use several credit rating agencies to risk-weight their exposures. Third, the minimum capital requirements for the corporate, interbank and sovereign loan portfolios of EMU banks will be higher in Basel II than in Basel I. I also show that the incentive for banks to engage in regulatory arbitrage in the standardized approach to credit risk is limited.
Keywords: New Basel Accord, capital requirements, credit rating agencies
JEL Classification: G21, G28
Suggested Citation: Suggested Citation
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