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Credit risk measurement and procyclicality

  • Philip Lowe

    (Reserve Bank of Australia)

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    This paper examines the two-way linkages between credit risk measurement and the macroeconomy. It first discusses the issue of whether credit risk is low or high in economic booms. It then reviews how macroeconomic considerations are incorporated into credit risk models and the risk measurement approach that underlies the New Basel Capital Accord. Finally, it asks what effect these measurement approaches are likely to have on the macroeconomy, particularly through their role in influencing the level of bank capital. The paper argues that much remains to be done in integrating macroeconomic considerations into risk measurement, particularly during the upswing of business cycles that are characterised by rapid increases in credit and asset prices. It also suggests that a system of risk-based capital requirements is likely to deliver large changes in minimum requirements over the business cycle, particularly if risk measurement is based on market prices. This has the potential to increase the financial amplification of business cycles, although other aspects of risk-based capital requirements are likely to work in the other direction. Further work on evaluating the net effects is important for both supervisory and monetary authorities.

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    File URL: http://www.bis.org/publ/work116.pdf
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    Paper provided by Bank for International Settlements in its series BIS Working Papers with number 116.

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    Length: 23 pages
    Date of creation: Sep 2002
    Date of revision:
    Handle: RePEc:bis:biswps:116
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    1. Pamela Nickell & William Perraudin & Simone Varotto, 2001. "Stability of ratings transitions," Bank of England working papers 133, Bank of England.
    2. Francis X. Diebold & Glenn D. Rudebusch & Daniel E. Sichel, 1991. "Further evidence on business cycle duration dependence," Working Papers 91-11, Federal Reserve Bank of Philadelphia.
    3. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers sp130, Financial Markets Group.
    4. Pierre-Olivier Gourinchas & Rodrigo Valdes & Oscar Landerretche, 2001. "Lending Booms: Latin America and the World," NBER Working Papers 8249, National Bureau of Economic Research, Inc.
    5. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements.
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