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Forecasting and Stress-testing the Risk-based Capital Requirements for Revolving Retail Exposures

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Author Info

  • Dunbar, Kwamie

    ()
    (John F. Welch College of Business, Sacred Heart University)

Abstract

This paper presents a tractable and empirically sound technique for generating stressed probabilities of default (PDs) which are then used to derive loss rates for the provisioning of a bank’s risk-based capital. This work is in response to the recent regulatory findings attributed to the Supervisory Capital Assessment Program (SCAP) stress tests of 2009 which revealed weaknesses in the existing regulatory and economic capital approaches. The SCAP projected losses of approximately $82.4 Billion in banks’ credit card portfolios for 2010, highlighting the need for better forecasting and stress testing of revolving retail exposures. This study proposes a timely model that will improve the ability of banks to determine the capital adequacy of revolving retail exposures. Using options theory we discuss why an obligor may default and produce estimates of expected losses from our stressed PDs so as to determine loss provisions. This method relies on the simulation of PD distributions via changes in selected macroeconomic variables and the card holder’s debt to income ratio (DTIR). The methodology offers the flexibility of being tractable and scalable to data in the issuer’s credit card portfolio by geography and credit quality of the obligor.

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File URL: http://repec.sacredheart.edu/she/pdf/wp2012_001.pdf
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File Function: First version, 2012
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Bibliographic Info

Paper provided by Sacred Heart University, John F. Welch College of Business in its series Working Papers with number 2012001.

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Length: 28 pages
Date of creation: Apr 2012
Date of revision:
Handle: RePEc:she:wpaper:2012001

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Web page: http://www.sacredheart.edu/pages/15_john_f_welch_college_of_business.cfm
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Keywords: Capital Requirement; Stress-test; capital adequacy;

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  1. Edward S. Knotek & II, 2007. "How useful is Okun's law?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 73-103.
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