Marking-to-model credit and operational risks of loan commitments: A Basel-2 advanced internal ratings-based approach
AbstractWithin a marking-to-model framework, this research computes the bank's capital charge for credit and operational risks of loan commitments at Basel-2 fixed audit date. This is done in three steps. The first one prices commitment credit risk as a Gram-Charlier put value and determines the commitment forward-funding proportion. In the second one, put value and funding proportion are combined to compute Basel-2 'fair' capital charge for credit and operational risks. By producing a moderate total capital charge, marking-to-model offers substantial capital relief with respect to the corresponding charge computed with Basel-2 simplified approach. Both charges are however larger than the corresponding nil charge arrived at in Basel-1. In the third step, marking-to-model reveals its flexibility by showing how banks can determine the cost of their exposure to borrowers' credit-rating downgrades and how they can also hedge any exposure to commitment default risk.
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Bibliographic InfoArticle provided by Elsevier in its journal International Review of Financial Analysis.
Volume (Year): 18 (2009)
Issue (Month): 5 (December)
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Web page: http://www.elsevier.com/locate/inca/620166
Constrained Gram-Charlier put Forward funding proportion Marking to model versus Basel-2 simplified approach Credit-risk downgrades Hedging commitment default risk;
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