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Consistency of banks' internal probability of default estimates: Empirical evidence from the COVID-19 crisis

Author

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  • Stepankova, Barbora
  • Teply, Petr

Abstract

The Basel III post-crisis reforms target the application of internal credit risk models for the estimation of the risk weighted assets of banks due to concerns about model risk. We use a unique dataset of 4.9 million probability of default (PD) estimates covering the January 2016 - June 2020 period sourced from 28 global banks to provide a deep insight into the comparability of model outputs. Our contribution is four-fold. Firstly, we confirm that there is a substantial variance in credit risk estimates. Secondly, we show that the level of PD variance is dependent on the entity type, industry, and location. Thirdly, we conclude that a considerable part of the variance is systematic, especially for credit risk estimates of funds. Finally, we illustrate the massive impact of the COVID-19 pandemic on the PD variance. The results highlight areas with relatively larger comparability issues, and they can be used by regulators to design more targeted policies.

Suggested Citation

  • Stepankova, Barbora & Teply, Petr, 2023. "Consistency of banks' internal probability of default estimates: Empirical evidence from the COVID-19 crisis," Journal of Banking & Finance, Elsevier, vol. 154(C).
    • Handle: RePEc:eee:jbfina:v:154:y:2023:i:c:s037842662300167x
    DOI: 10.1016/j.jbankfin.2023.106969
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    References listed on IDEAS

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    4. Dainelli, Francesco & Bet, Gianmarco & Fabrizi, Eugenio, 2024. "The financial health of a company and the risk of its default: Back to the future," International Review of Financial Analysis, Elsevier, vol. 95(PB).

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    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • 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

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