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Credit Risk Assessment Considering Variations in Exposure: Application to Commitment Lines

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  • Shigeaki Fujiwara

    (Deputy Director and Economist, Institute for Monetary and Economic Studies (currently, Director and Economist, Financial Systems and Bank Examination Department), Bank of Japan (E-mail: shigeaki.fujiwara@boj.or.jp))

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    Abstract

    Given the worldwide financial market confusion caused by the subprime mortgage problem and the increase in credit line contracts with relaxed covenants, there have been cases in which financial institutions are facing a demand to provide additional credit to securitized vehicles with heightened liquidity and credit risks. These are typical examples demonstrating the importance of risk management considering variations in exposure. There are also calls for incorporation of future variations in exposure into the model for the Basel II advanced internal ratings-based approach. This paper adopts commitment lines as a credit provision with variable exposure and constructs a credit risk model whereby stochastic new borrowing demand is linked to changes in a firmfs asset value. Through simulations, the paper then considers the interdependence among exposure at default, probability of default, loss given default, expected loss, and unexpected loss. The paper also prepares a simple model for the covenants, and verifies the influence of the rigidness of covenants on expected loss and other risk factors.

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    File URL: http://www.imes.boj.or.jp/research/papers/english/me27-9.pdf
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    Bibliographic Info

    Article provided by Institute for Monetary and Economic Studies, Bank of Japan in its journal Monetary and Economic Studies.

    Volume (Year): 27 (2009)
    Issue (Month): 1 (November)
    Pages: 171-194

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    Handle: RePEc:ime:imemes:v:27:y:2009:i:1:p:171-194

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    Keywords: Commitment lines; Probability of default; Loss given default; Exposure at default; Expected loss; Unexpected loss;

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