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What determines creditor recovery rates?

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  • Nada Mora

Abstract

The 2007-09 financial crisis illustrated the importance of healthy banks for the overall stability of the financial system and economy. Because banking is inherently risky, the health of banks depends on their ability to manage risk and exposure to losses. ; An important component of a strong risk management system is a bank’s ability to assess the potential losses on its investments. One factor that determines the extent of losses is the recovery rate on loans and bonds that are in default. For example, the recovery rate is said to be 50 percent if the creditor is able to recover only half the amount of principal and accrued interest due. ; Drawing on more than 30 years of recovery data on defaulted debt instruments, Mora finds that the state of the economy helps determine creditor recovery rates. Industry distress also drives recovery rates, and evidence suggests industry distress can be triggered by a weak economy.

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Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.

Volume (Year): (2012)
Issue (Month): Q II ()
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Handle: RePEc:fip:fedker:y:2012:i:qii:n:v.97no.2:x:2

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  1. Max Bruche & Carlos González Aguado, 2006. "Recovery Rates, Default Probabilities And The Credit Cycle," Working Papers wp2006_0612, CEMFI.
  2. Daniel Covitz & Song Han, 2004. "An empirical analysis of bond recovery rates: exploring a structural view of default," Finance and Economics Discussion Series 2005-10, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Tatiana Damjanovic & Sarunas Girdenas, 2013. "Should Central Bank respond to the Changes in the Loan to Collateral Value Ratio and in the House Prices?," Discussion Papers 1303, Exeter University, Department of Economics.

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