Transmission of macro shocks to loan losses in a deep crisis: the case of Finland
AbstractBuilding on the work of Sorge and Virolainen (2006), we revisit the data on aggregate Finnish bank loan losses from the corporate sector, which covers the ‘Big Five’ crisis in Finland in the early 1990s. Several extensions to the empirical model are considered. These extensions are then used in the simulations of the aggregate loan loss distribution. The simulation results provide some guidance as to what might be the most important dimensions in which to improve the basic model. We found that making the average LGD depend on the business cycle seems to be the most important improvement. We also compare the empirical fit of the annual expected losses over a long period. In scenario-based analyses we find that a prolonged deep recession (as well as simultaneity of various macro shocks) has a convex effect on cumulative loan losses. This emphasizes the importance of an early policy response to a looming crisis. Finally, a comparison of the loan loss distribution on the eve of the 1990s crisis with the most recent distribution demonstrates the greatly elevated risk level prior to the 1990s crisis.
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Bibliographic InfoPaper provided by Bank of Finland in its series Research Discussion Papers with number 26/2009.
Length: 31 pages
Date of creation: 02 Nov 2009
Date of revision:
credit risk; bank loan losses; banking crisis; macro shocks; default rates; stress testing;
Find related papers by JEL classification:
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- E37 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Forecasting and Simulation: Models and Applications
- G01 - Financial Economics - - General - - - Financial Crises
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-12-11 (All new papers)
- NEP-BAN-2009-12-11 (Banking)
- NEP-CBA-2009-12-11 (Central Banking)
- NEP-RMG-2009-12-11 (Risk Management)
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