Assessing the effects of collaterals and guarantee on loan pricing under the IRB approach: a comparative-static analysis R. De Lisa*, M. Marchesi**, F. Vallascas*, S. Zedda* 2007 Small business banking and financing: a global perspective Cagliari, 25th May, 2007. - PowerPoint PPT Presentation
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Assessing the effects of collaterals and Assessing the effects of collaterals and guarantee on loan pricing under the IRB guarantee on loan pricing under the IRB approach: a comparative-static analysis approach: a comparative-static analysis R. De Lisa*, M. Marchesi**, F. Vallascas*, S. Zedda* R. De Lisa*, M. Marchesi**, F. Vallascas*, S. Zedda* 2007 Small business banking and 2007 Small business banking and financing: financing: a global perspective a global perspective Cagliari, Cagliari, 25th May, 2007 25th May, 2007 *: University of Cagliari (Economics of Financial Intermediaries; Financial Mathematics) *: University of Cagliari (Economics of Financial Intermediaries; Financial Mathematics) **: European Commission, Dg Internal Market **: European Commission, Dg Internal Market
Transcript
Assessing the effects of collaterals and Assessing the effects of collaterals and guarantee on loan pricing under the IRB guarantee on loan pricing under the IRB approach: a comparative-static analysisapproach: a comparative-static analysis
R. De Lisa*, M. Marchesi**, F. Vallascas*, S. Zedda*R. De Lisa*, M. Marchesi**, F. Vallascas*, S. Zedda*
2007 Small business banking and 2007 Small business banking and financing:financing:a global perspective a global perspective Cagliari,Cagliari, 25th May, 2007 25th May, 2007
*: University of Cagliari (Economics of Financial Intermediaries; Financial Mathematics)*: University of Cagliari (Economics of Financial Intermediaries; Financial Mathematics)
**: European Commission, Dg Internal Market**: European Commission, Dg Internal Market
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Directive on capital adequacy of Directive on capital adequacy of credit institutions (2006)credit institutions (2006)
New regulation on the treatment of capital New regulation on the treatment of capital adequacy:adequacy:
a)a) risk-sensitive capital adequacy;risk-sensitive capital adequacy;
b)b) Fully recognition of “mitigation techniques” (as Fully recognition of “mitigation techniques” (as collaterals and guarantees – C&G) . collaterals and guarantees – C&G) .
Lower loan overall credit risk Lower level of own Lower loan overall credit risk Lower level of own fundsfunds
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Loan pricing and C&GLoan pricing and C&G
If the banks’ criteria is based upon the If the banks’ criteria is based upon the evaluation of credit risk components, C&G evaluation of credit risk components, C&G topic becomes relevant.topic becomes relevant.
Micro perspectiveMicro perspective: C&G as a sort of “regulatory : C&G as a sort of “regulatory driver” than can be used in the pricing driver” than can be used in the pricing negotiation process.negotiation process.
Macro perspectiveMacro perspective: C&G could have : C&G could have implications on the overall allocative efficiency implications on the overall allocative efficiency of the credit industry.of the credit industry.
Thus, it is worth to assess the impact of C&G Thus, it is worth to assess the impact of C&G on loan pricing.on loan pricing.
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The aim of the paper The aim of the paper
The paper aims at providing a quantitative The paper aims at providing a quantitative assessment of the impacts of C&G on a loan assessment of the impacts of C&G on a loan pricingpricing
A comparative-static analysis applied to a A comparative-static analysis applied to a pricing model*. pricing model*.
Pricing model is defined by following Pricing model is defined by following Loan Loan arbitrage-free pricing modelsarbitrage-free pricing models (LAFP). (LAFP). Dermine (1996)Dermine (1996)
*: Under Internal rating based approach.*: Under Internal rating based approach.
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Methodology: pricing functionMethodology: pricing function
jj
jjddjdejjjddj LGDPD
LGDPDiicopirCLGDPDiiiSpread
1
jj
j
jj
dej
jj
djjdj
LGDPD
cop
LGDPD
irC
LGDPD
iLGDPDiiSpread
111
1
Expected loss component
Unexpected loss component
Organizational component
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Methodology: Modelling the impact Methodology: Modelling the impact of collateralsof collaterals
jj
j
jj
dej
jj
djj
LGDPD
cop
LGDPD
irC
LGDPD
iLGDPDSpread
111
1
LGD C
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Methodology: Modelling the impact Methodology: Modelling the impact of guaranteesof guarantees
jj
j
jj
dej
jj
djj
LGDPD
cop
LGDPD
irC
LGDPD
iLGDPDSpread
111
1
PD C
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Methodology: pricing modelMethodology: pricing model
\
0,5 0,5
1
10,999
11
1 1,5 1 2,5 1,06
jj j j j j
jj
j j j
RC LGD N G PD G PD LGD
RR
b M b
cumulative distribution function for a standard normal random variable
G (x)
N (x)
inverse cumulative distribution function for a standard normal random variable
45/5104,0
501/501124,0501/50112,0
S
EXPPDEXPEXPPDEXPR
correlation proxy
2
0.11852 0.05478j jb Log PD maturity adjustment
jM effective maturity
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Methodology: pricing modelMethodology: pricing model
(1)
****
*
**
**
111
1
jj
j
jj
dej
jj
djj
LGDPD
cop
LGDPD
irC
LGDPD
iLGDPDSpread
(2) GDJ PDPDPD 1*
0
(3)
E
MVCEMAXLGDJ %45;0*
%450 *LGD 0MVC
(4) 06,15,215,11999,01
1 1*5,0
5,0**
bMbLGDPDG
R
RPDGRNLGDC j
1010
Methodology: limitsMethodology: limits
1) The analysis is based on a “technical” 1) The analysis is based on a “technical” spreadspread
06,15,215,11999,01
1 1*5,0
5,0**
bMbLGDPDG
R
RPDGRNLGDC j
****
*
**
**
111
1
jj
j
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dej
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LGDPD
cop
LGDPD
irC
LGDPD
iLGDPDSpread
2) C* is the “minimum capital required”2) C* is the “minimum capital required”
Expected Loss Unexpected Loss Organizational components
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Main results (02)Main results (02)
Elasticities of credit spread with respect to PD and LGD
0.02 0.04 0.06 0.08Pd
0.1
0.2
0.3
0.4
0.5
0.6
spread, LGD
spread, PD
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Main results (03)Main results (03)
Elasticities of capital requirement with respect to LGD and PD
C, LGD
C, PD
0.02 0.04 0.06 0.08PDd
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
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Main results (04)Main results (04)
Elasticities of credit spread with respect to MVC and (given a guarantor’s PD of 0,03% and borrower’s PD of 1,4%)
0.2 0.4 0.6 0.8 1alpha, mvc
-0.4
-0.3
-0.2
-0.1
spread,
spread, MVC
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Main results (04)Main results (04)
0.2 0.4 0.6 0.8 1alpha, mvc
-0.4
-0.3
-0.2
-0.1
spread,
spread, MVC
Elasticities of credit spread with respect to MVC and (given a guarantor’s PD of 0,15% and borrower’s PD of 1,4%)
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Main conclusionsMain conclusions
1. Collaterals are the strongest mitigation tool1. Collaterals are the strongest mitigation tool1.1. more evident when borrower’s PD 1.1. more evident when borrower’s PD is high is high
No neutral regulationNo neutral regulation
2. Credit spreads are more elastic to C&G than 2. Credit spreads are more elastic to C&G than borrower’s rating improvementsborrower’s rating improvements
2.1. great appeal in releasing C&G, less in upgrading rating class2.1. great appeal in releasing C&G, less in upgrading rating class
2.2. likely impacts on allocative efficiency2.2. likely impacts on allocative efficiency
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Further research issues:Further research issues:
A) Modelling bank and firm behaviourA) Modelling bank and firm behaviour
1.1. BankBank::
- economic capital vs. regulatory capital- economic capital vs. regulatory capital
2.2. FirmFirm::
- cost of alternative choices- cost of alternative choices
B) Modelling the impact guarantees under the B) Modelling the impact guarantees under the double default approachdouble default approach
