Loan Pricing Under Basel Capital Requirements
AbstractWe analyse the implications for the pricing of bank loans of the reform of capital regulation known as Basel II. We consider a perfectly competitive market for business loans where, as in the model underlying the internal ratings based (IRB) approach of Basel II, a single risk factor explains the correlation in defaults across firms. Our loan pricing equation implies that low-risk firms will achieve reductions in their loan rates by borrowing from banks adopting the IRB approach, while high-risk firms will avoid increases in their loan rates by borrowing from banks that adopt the less risk-sensitive standardized approach of Basel II. We also show that only an extremely high social cost of bank failure might justify the proposed IRB capital charges for high-risk loans, partly because the margin income from performing loans is not counted as a buffer against credit losses, and we propose a margin income correction for IRB capital requirements.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3917.
Date of creation: May 2003
Date of revision:
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Other versions of this item:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-06-13 (All new papers)
- NEP-CFN-2004-06-13 (Corporate Finance)
- NEP-FIN-2004-06-13 (Finance)
- NEP-REG-2004-06-13 (Regulation)
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