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

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  • 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 in risk 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-based 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 might be amplified by developments in the banking industry.

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    File URL: http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmgdps/DP428.pdf
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    Bibliographic Info

    Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp428.

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    Date of creation: Sep 2002
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    Handle: RePEc:fmg:fmgdps:dp428

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    Web page: http://www.lse.ac.uk/fmg/

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    Cited by:
    1. Ali, Syed Babar, 2012. "Quality of Internal Risk Rating Frameworks at Commercial Banks in Pakistan," MPRA Paper 55117, University Library of Munich, Germany.
    2. Eva Catarineu-Rabell & Patricia Jackson & Dimitrios P.Tsomocos, 2003. "Procyclicality and the new Basel Accord - Banks' choice of loan rating system," OFRC Working Papers Series 2003fe06, Oxford Financial Research Centre.
    3. Ines Drumond, 2009. "Bank Capital Requirements, Business Cycle Fluctuations And The Basel Accords: A Synthesis," Journal of Economic Surveys, Wiley Blackwell, vol. 23(5), pages 798-830, December.
    4. Athanasoglou, Panayiotis P. & Daniilidis, Ioannis & Delis, Manthos D., 2014. "Bank procyclicality and output: Issues and policies," Journal of Economics and Business, Elsevier, vol. 72(C), pages 58-83.
    5. 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.
    6. repec:onb:oenbwp:y:2003:i:5:b:1 is not listed on IDEAS
    7. Miguel A. Segoviano & Charles Goodhart, 2010. "Distress Dependence and Financial Stability," Working Papers Central Bank of Chile 569, Central Bank of Chile.
    8. 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.
    9. Miguel A. Segoviano Basurto, 2006. "Portfolio Credit Risk and Macroeconomic Shocks," IMF Working Papers 06/283, International Monetary Fund.
    10. Rodríguez Dupuy, Analía, 2007. "Loan portfolio loss distribution: Basel II unifactorial approach vs. Non parametric estimations," MPRA Paper 10697, University Library of Munich, Germany.
    11. 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.
    12. 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.
    13. 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.
    14. 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.
    15. Peresetsky, Anatoly A. & Karminsky, Alexandr A. & Golovan, Sergei V., 2004. "Probability of default models of Russian banks," BOFIT Discussion Papers 21/2004, Bank of Finland, Institute for Economies in Transition.

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