Abstract
The credit risk management process is a critical element that allows financial institutions to withstand economic downturns. Unlike the methods regarding the probability of default, which have been deeply addressed after the financial crisis in 2008, recovery rate models still need further development. As there are no industry standards, leading banks are modeling recovery rates using internal models developed with different assumptions. Therefore, the outcomes are often incomparable and may lead to confusion. The author presents the concept of a unified recovery rate analysis for US banks. He uses data derived from FR Y-9C reports disclosed by the Federal Reserve Bank of Chicago. Based on the historical recoveries and credit portfolio book values, the author examines the distribution function of recoveries. The research refers to a credit card portfolio and covers nine leading US banks. The author leveraged Vasicek’s one-factor model with the asset correlation parameter and implemented it for recovery rate analysis. This experiment revealed that the estimated latent correlation ranges from 0.2% to 1.5% within the examined portfolios. They are large enough to impact the recovery rate volatility and cannot be treated as negligible. It was shown that the presented method could be applied under US Comprehensive Capital Analysis and Review exercise.
Highlights
One of the New Basel Capital Accord’s purposes was to reduce the discrepancy between regulatory and economic capital
It was shown that the presented method could be applied under US Comprehensive Capital Analysis and Keywords: LGD; recovery rate; retail loans; credit risk
All United States Bank Holding Companies are obliged to submit these reports once their consolidated assets exceed 500 million
Summary
One of the New Basel Capital Accord’s purposes was to reduce the discrepancy between regulatory and economic capital. The Basel Committee is motivating financial institutions to develop their internal risk models. They were granted significant autonomy in this area. The socalled standardized approach is based on Basel I, and is still the most popular method utilized for capital requirement calculation. According to this approach, banks calculate the risk weights dedicated to specific asset classes. Banks calculate the risk weights dedicated to specific asset classes These weights reflect the potential unexpected losses. According to Basel II [1] the banks are expected to develop internal credit risk models and their further implementation within the risk management process. The fifth quantitative research QIS52 clearly showed that some capital benefits are expected for well-diversified retail portfolios
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