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Internal ratings, the business cycle, and capital requirements: some evidence from an emerging market economy

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  • Miguel Angel Segoviano
  • Philip Lowe
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    Abstract

    The concept of risk-based capital requirements enjoys widespread support. Effective implementation, however, requires that risk be measured accurately both across borrowers and across time. Under the New Capital Accord, the cornerstone of this risk measurement process is the rating of the borrower. In this paper we use the ratings assigned by individual Mexican banks to examine how measured credit risk for these banks has changed since the financial crisis in the mid 1990s. We then examine the implications of these changes for regulatory capital under the proposed changes to the Basel Capital Accord. We find that measured risk increased after the crisis and then fell as the recovery took hold. In turn, despite the limitations of the data, we find that the proposed internal ratings approach would have generated large swings in regulatory capital requirements over the second half of the 1990s, with required capital increasing significantly in the aftermath of the crisis, and then falling as the economy recovered. Looking forward, if movements in actual bank capital were to show this same cyclical variation, then business cycle fluctuations may be amplified by developments in the banking industry.

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    Bibliographic Info

    Article provided by Federal Reserve Bank of Boston in its journal Conference Series ; [Proceedings].

    Volume (Year): (2002)
    Issue (Month): ()
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    Handle: RePEc:fip:fedbcp:y:2002:x:7

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    Keywords: Risk management ; Banks and banking;

    References

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    1. Bangia, Anil & Diebold, Francis X. & Kronimus, Andre & Schagen, Christian & Schuermann, Til, 2002. "Ratings migration and the business cycle, with application to credit portfolio stress testing," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 445-474, March.
    2. Michael B. Gordy, 1998. "A comparative anatomy of credit risk models," Finance and Economics Discussion Series 1998-47, Board of Governors of the Federal Reserve System (U.S.).
    3. Powell, Andrew, 2002. "A capital accord for emerging economies?," Policy Research Working Paper Series 2808, The World Bank.
    4. Joe Peek & Eric S. Rosengren, 1997. "Collateral damage: effects of the Japanese real estate collapse on credit availability and real activity in the United States," Working Papers 97-5, Federal Reserve Bank of Boston.
    5. Edward I. Altman & Andrea Resti & Andrea Sironi, 2002. "The link between default and recovery rates: effects on the procyclicality of regulatory capital ratios," BIS Working Papers 113, Bank for International Settlements.
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    Cited by:
    1. Eva Catarineu-Rabell & Patricia Jackson & Dimitrios P Tsomocos, 2003. "Procyclicality and the new Basel Accord - banks' choice of loan rating system," Bank of England working papers 181, Bank of England.
    2. Inês Drumond, 2008. "Bank Capital Requirements, Business Cycle Fluctuations and the Basel Accords: A Synthesis," FEP Working Papers 277, Universidade do Porto, Faculdade de Economia do Porto.
    3. Anatoly Peresetsky & Alexandr Karminsky & Sergei Golovan, 2011. "Probability of default models of Russian banks," Economic Change and Restructuring, Springer, vol. 44(4), pages 297-334, November.
    4. Rubén Ascúa, 2006. "Financial Instruments for Argentine SMEs afterthe Crisis.Teachings from the German Case," Proceedings-4th International Conference on Management, Enterprise and Benchmarking (MEB 2006), Óbuda University, Keleti Faculty of Business and Management.
    5. C. A. E. Goodhart & Miguel A. Segoviano Basurto & Boris Hofmann, 2006. "Default, Credit Growth, and Asset Prices," IMF Working Papers 06/223, International Monetary Fund.
    6. Athanasoglou, Panayiotis & Ioannis, Daniilidis & Manthos, Delis, 2013. "Bank procyclicality and output: Issues and policies," MPRA Paper 50830, University Library of Munich, Germany.
    7. Fabrizio Fabi & Sebastiano Laviola & Paolo Marullo Reedtz, 2004. "The treatment of SMEs loans in the New Basel Capital Accord: some evaluations," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 57(228), pages 29-70.
    8. Ali, Syed Babar, 2012. "Quality of Internal Risk Rating Frameworks at Commercial Banks in Pakistan," MPRA Paper 55117, University Library of Munich, Germany.
    9. Fabrizio Fabi & Sebastiano Laviola & Paolo Marullo Reedtz, 2004. "The treatment of SMEs loans in the New Basel Capital Accord: some evaluations," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 57(228), pages 29-70.
    10. Miguel A. Segoviano & Charles Goodhart, 2010. "Distress Dependence and Financial Stability," Working Papers Central Bank of Chile 569, Central Bank of Chile.
    11. Vanessa Redak & Alexander Tscherteu, 2003. "Basel II, Procyclicality and Credit Growth - First Conclusions from QIS 3," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 5, pages 56-69.
    12. repec:onb:oenbwp:y:2003:i:5:b:1 is not listed on IDEAS
    13. Rodriguez, Analía, 2007. "Distribución de pérdidas de la cartera de créditos: el método unifactorial de Basilea II vs. estimaciones no paramétricas," MPRA Paper 12637, University Library of Munich, Germany.
    14. Miguel A. Segoviano Basurto, 2006. "Portfolio Credit Risk and Macroeconomic Shocks," IMF Working Papers 06/283, International Monetary Fund.
    15. Rodríguez Dupuy, Analía, 2007. "Loan portfolio loss distribution: Basel II unifactorial approach vs. Non parametric estimations," MPRA Paper 10697, University Library of Munich, Germany.
    16. Markus Behn & Rainer Haselmann & Paul Wachtel, 2013. "Pro-Cyclical Capital Regulation and Lending," Working Papers 13-11, New York University, Leonard N. Stern School of Business, Department of Economics.

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