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Modelling Bank Loan LGD of Corporate and SME Segments: A Case Study

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Abstract

The aim of this paper is to propose a methodology to estimate loss given default (LGD) and apply it to a set of micro-data of loans to SME and corporations of an anonymous commercial bank from Central Europe. LGD estimates are important inputs in the pricing of credit risk and the measurement of bank profitability and solvency. Basel II Advance IRB Approach requires internally estimates of LGD to calculate risk-weighted assets and to estimate expected loss. We analyse the recovery rate dynamically over time and identify the efficient recovery period of a workout department. Moreover, we focus on the appropriate choice of a discount factor by introducing risk premium based on a risk level of collaterals. We apply statistical methods to estimate LGD and test empirically its determinants. Particularly, we analyse generalised linear models using symmetric logit and asymmetric log-log link functions for ordinal responses as well as for fractional responses. For fractional responses we employ two alternatives, a beta inflated distribution and a quasi-maximum likelihood estimator. We find out that the main drivers of LGD are a relative value of collateral, a loan size as well as a year of the loan origination. Different models provided similar results. As for the different links in more complex models, log-log models in some cases perform better, implying an asymmetric response of the dependent variable.

Suggested Citation

  • Radovan Chalupka & Juraj Kopecsni, 2008. "Modelling Bank Loan LGD of Corporate and SME Segments: A Case Study," Working Papers IES 2008/27, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Nov 2008.
  • Handle: RePEc:fau:wpaper:wp2008_27
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    1. Radovan Chalupka & Juraj Kopecsni, 2008. "Modelling Bank Loan LGD of Corporate and SME Segments: A Case Study," Working Papers IES 2008/27, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Nov 2008.
    2. Jakub Seidler & Petr Jakubík, 2009. "Implied Market Loss Given Default in the Czech Republic: Structural-Model Approach," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 59(1), pages 20-40, January.
    3. Radovan Chalupka & Juraj Kopecsni, 2009. "Modeling Bank Loan LGD of Corporate and SME Segments: A Case Study," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 59(4), pages 360-382, Oktober.
    4. Renault, Olivier & Scaillet, Olivier, 2004. "On the way to recovery: A nonparametric bias free estimation of recovery rate densities," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 2915-2931, December.
    5. Papke, Leslie E & Wooldridge, Jeffrey M, 1996. "Econometric Methods for Fractional Response Variables with an Application to 401(K) Plan Participation Rates," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(6), pages 619-632, Nov.-Dec..
    6. Mark Carey, 1998. "Credit Risk in Private Debt Portfolios," Journal of Finance, American Finance Association, vol. 53(4), pages 1363-1387, August.
    7. Thorburn, Karin S., 2000. "Bankruptcy auctions: costs, debt recovery, and firm survival," Journal of Financial Economics, Elsevier, vol. 58(3), pages 337-368, December.
    8. Jon Frye, 2000. "Depressing recoveries," Emerging Issues, Federal Reserve Bank of Chicago, issue Oct.
    9. Dermine, J. & de Carvalho, C. Neto, 2006. "Bank loan losses-given-default: A case study," Journal of Banking & Finance, Elsevier, vol. 30(4), pages 1219-1243, April.
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    Cited by:

    1. Elmas Yaldiz Hanedar & Eleonora Broccardo & Flavio Bazzana, 2012. "Collateral Requirements of SMEs:The Evidence from Less–Developed Countries," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 12111, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    2. Yaldız Hanedar, Elmas & Broccardo, Eleonora & Bazzana, Flavio, 2014. "Collateral requirements of SMEs: The evidence from less-developed countries," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 106-121.
    3. Jakub Seidler & Petr Jakubík, 2009. "Implied Market Loss Given Default in the Czech Republic: Structural-Model Approach," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 59(1), pages 20-40, January.
    4. Radovan Chalupka & Juraj Kopecsni, 2008. "Modelling Bank Loan LGD of Corporate and SME Segments: A Case Study," Working Papers IES 2008/27, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Nov 2008.
    5. Mark McGovern, 2012. "Don't Stress: Early Life Conditions, Hypertension, and Selection into Associated Risk Factors," Working Papers 201227, School of Economics, University College Dublin.
    6. Radovan Chalupka & Juraj Kopecsni, 2009. "Modeling Bank Loan LGD of Corporate and SME Segments: A Case Study," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 59(4), pages 360-382, Oktober.
    7. Yang, Bill Huajian & Tkachenko, Mykola, 2012. "Modeling of EAD and LGD: Empirical Approaches and Technical Implementation," MPRA Paper 57298, University Library of Munich, Germany.
    8. Luca Fornaro & Gianluca Benigno, 2015. "Stagnation Traps," 2015 Meeting Papers 810, Society for Economic Dynamics.
    9. Yashkir, Olga & Yashkir, Yuriy, 2013. "Loss Given Default Modelling: Comparative Analysis," MPRA Paper 46147, University Library of Munich, Germany.
    10. Konstantin Belyaev & Aelita Belyaeva & Tomas Konecny & Jakub Seidler & Martin Vojtek, 2012. "Macroeconomic Factors as Drivers of LGD Prediction: Empirical Evidence from the Czech Republic," Working Papers 2012/12, Czech National Bank, Research Department.
    11. Han, Chulwoo & Jang, Youngmin, 2013. "Effects of debt collection practices on loss given default," Journal of Banking & Finance, Elsevier, vol. 37(1), pages 21-31.
    12. repec:fau:fauart:v:67:y:2017:i:6:p:462-491 is not listed on IDEAS

    More about this item

    Keywords

    credit risk; bank loan; loss given default; LGD; recovery rate; fractional responses; ordinal regression; quasi-maximum likelihood estimator;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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