Abstract
The traditional loans pricing methods are usually based on risk measures of individual loan’s characteristics without considering the correlation between the defaults of different loans and the contribution of individual loans to the entire loan portfolio. In this study, using account-level loans data of 2010-2016 abstracted from 2 databases kindly provided by a Chinese commercial bank, the authors choose Archimedean Copula to fit the default relationship between loans, combined with the loss distribution function constructed to measure the economic capital of the loan portfolio, to propose a loan pricing method that is more suitable for measuring the unique risk characteristic of SMEs loans. Empirical evidence shows that compared with the traditional loan pricing model, this new proposed one, requiring lower loan interest rates from customers with higher credit rating, while higher loan interest rates from customers with lower credit rating, could thus be able to provide higher risk-adjusted returns, higher economic capital adequacy ratios, and ultimately stronger banks’ capabilities to tolerate risk events. Although there might still be some issues and limitations in the study, the method proposed in this study could be of interest not only to the banks’ management, but also to banking regulators as well.
Highlights
The approach for pricing loans of commercial banks basically adopts the way of adjusting certain premium/discount points based on the benchmark interest rates, with premiums/ discounts often reflects the credit ratings of the firms applying the loans
As a permitted by Basel III, this paper selects the Archimedean Copula method to fit the default relationship between loans, together with the loss distribution function constructed to measure the economic capital of the loan portfolio and the marginal contribution of a single loan considered when computing the marginal economic capital consumption and the price of that loan
A loan decision-making and loan pricing system based on RAROC is constructed
Summary
The approach for pricing loans of commercial banks basically adopts the way of adjusting certain premium/discount points based on the benchmark interest rates, with premiums/ discounts often reflects the credit ratings of the firms applying the loans. The client rating system has a rating module specific to small and medium-sized enterprises (SMEs), the specific rating indicators tend to follow the metrics of large-scale. The idea of this study can be summarized as follows: First, based on the analysis of SMEs loans’ risk characteristics, this paper constructs a scoring system suitable for the credit risk measurement of SME applicants for loans of one Chinese commercial bank.
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