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2024 | OriginalPaper | Chapter

Measuring of Inferred Loss Rate with Application to Capital Adequacy

Author : Vilislav Boutchaktchiev

Published in: New Trends in the Applications of Differential Equations in Sciences

Publisher: Springer Nature Switzerland

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Abstract

The loss rate of a bank’s portfolio traditionally measures what portion of the exposure is lost in case of default. To overcome the lack of private data and the difficulties involved in its computation, we introduce the notion of implied loss rate (ILR). We prove that ILR is sufficiently close to the actual loss rate in properties that facilitates capital adequacy analysis. To further demonstrate its usefulness, as an example, we estimate ILR for portfolios in the Bulgarian bank system using data on the quality of assets of bank groups reported by the Bulgarian National Bank.

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previous chapter Mixed Approach Between Capital Asset Pricing Model and ARIMA Model for Estimating the Standard and Poor’s Stocks

next chapter Comparative Analysis on Neural Networks and ARIMA for Forecasting Heterogeneous Portfolio Returns

According to a regulation of the European Banking Authority, any bank needs to maintain a minimum capital adequacy of 8% of its total risk-weighted assets. Tot that, the local regulator, the Bulgarian National Bank, adds a variety of mandatory buffers, which amount to an additional 7%. Furthermore, the 8 largest banks in the country are loaded with an extra 0.5–1% for having concentrated a larger share of the systemic risk. Finally, on top of that, each bank has its mandatory buffer for idiosyncratic risk of 1.25–2%. In total, the mandatory minimum of a Bulgarian bank is between 16.5 and 18.5%.

In a credit portfolio, the loss rates are usually bounded. Conditional independence is a technical requirement that is, often, violated in smaller portfolios.

Condition 2 is sufficient to guarantee fine granularity of the portfolio.

Conditions 3, 4, and 5 are technical conditions, that could eventually be weekended in practice.

The Bulgarian banks are classified into three groups: Group 1 is built of the five largest banks, Group 3 contains the offices of foreign banks not incorporated in Bulgaria, and Group 2 all the rest.

Smaller banks in Bulgaria have only an equivalent national rating provided by a national credit rating agency.

Basel Committee on Banking Supervision Prudential treatment of problem assets — definitions of non-performing exposures and forbearance, Consultative Document. BIS, July 15, 2016.

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Title: Measuring of Inferred Loss Rate with Application to Capital Adequacy
Author: Vilislav Boutchaktchiev
Publisher: Springer Nature Switzerland
Book: New Trends in the Applications of Differential Equations in Sciences
Print ISBN: 978-3-031-53211-5

Electronic ISBN: 978-3-031-53212-2

Copyright Year: 2024
DOI: https://doi.org/10.1007/978-3-031-53212-2_29

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