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Credit risk measurement and procyclicality

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  • Philip Lowe

    (Reserve Bank of Australia)

Abstract

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.

Suggested Citation

  • Philip Lowe, 2002. "Credit risk measurement and procyclicality," BIS Working Papers 116, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:116
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    References listed on IDEAS

    as
    1. Pierre-Olivier Gourinchas & Rodrigo Valdes & Oscar Landerretche, 2001. "Lending Booms: Latin America and the World," ECONOMIA JOURNAL, THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION - LACEA, vol. 0(Spring 20), pages 47-100, January.
    2. Nickell, Pamela & Perraudin, William & Varotto, Simone, 2000. "Stability of rating transitions," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 203-227, January.
    3. Francis X. Diebold & Glenn Rudebusch & Daniel Sichel, 1993. "Further Evidence on Business-Cycle Duration Dependence," NBER Chapters,in: Business Cycles, Indicators and Forecasting, pages 255-284 National Bureau of Economic Research, Inc.
    4. Con Keating & Hyun Song Shin & Charles Goodhart & Jon Danielsson, 2001. "An Academic Response to Basel II," FMG Special Papers sp130, Financial Markets Group.
    5. Gabriele Galati & Kostas Tsatsaronis, 2001. "The impact of the euro on Europe's financial markets," BIS Working Papers 100, Bank for International Settlements.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    credit risk measurement; macroeconomy;

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