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Are Banks' Internal Risk Parameters Consistent? Evidence from Syndicated Loans

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  • Firestone, Simon

    ()
    (Board of Governors of the Federal Reserve System (U.S.))

  • Rezende, Marcelo

    ()
    (Board of Governors of the Federal Reserve System (U.S.))

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    Abstract

    This paper examines consistency in the estimates of probability of default (PD) and loss given default (LGD) that nine large U.S. banks assign to syndicated loans for regulatory capital purposes. Using internal bank data on loans that had PDs and LGDs assigned by more than one bank, we find substantial dispersion in these parameters. Banks differ substantially in PDs, but only a few set PDs systematically higher or lower than the median bank. However, many banks differ from the median bank systematically in LGDs, and these differences affect their Basel II minimum regulatory capital significantly. The differences in LGDs imply that, for an identical loan portfolio, the bank that sets the highest LGDs would have Basel II minimum regulatory capital twice as large as the bank that sets the lowest LGDs. We argue that these differences in risk parameters across banks can be at least partially explained by bank behavior that complies with the Basel rules. We also find a negative relation between banks' LGDs and their shares in loan syndicates, suggesting that differences in risk parameters have implications beyond bank capital.

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    File URL: http://www.federalreserve.gov/pubs/feds/2013/201384/201384pap.pdf
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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2013-84.

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    Length: 35 pages
    Date of creation: 01 Oct 2013
    Date of revision:
    Handle: RePEc:fip:fedgfe:2013-84

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    Keywords: Probability of default; loss given default; bank capital;

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    1. Pesaran, M.H. & Schuermann, T. & Treutler, B-J. & Weiner, S.M., 2003. "Macroeconomic Dynamics and Credit Risk: A Global Perspective," Cambridge Working Papers in Economics 0330, Faculty of Economics, University of Cambridge.
    2. Diana Bonfim, 2006. "Credit Risk Drivers: Evaluating the Contribution of Firm Level Information and of Macroeconomic Dynamics," Economic Bulletin and Financial Stability Report Articles, Banco de Portugal, Economics and Research Department.
    3. Tang, Dragon Yongjun & Yan, Hong, 2010. "Market conditions, default risk and credit spreads," Journal of Banking & Finance, Elsevier, vol. 34(4), pages 743-753, April.
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