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Credit Risk versus Capital Requirements under Basel II: Are SME Loans and Retail Credit Really Different?

Author

Listed:
  • Jacobson, Tor

    () (Research Department, Central Bank of Sweden)

  • Lindé, Jesper

    () (Research Department, Central Bank of Sweden)

  • Roszbach, Kasper

    () (Research Department, Central Bank of Sweden)

Abstract

The new Basel II regulation contains a number of new regulatory features. Most importantly, internal ratings will be given a central role in the evaluation of the riskiness of bank loans. Another novelty is that retail credit and loans to small and medium-sized enterprises will receive a special treatment in recognition of the fact that the riskiness of such exposure derives to a greater extent from idiosyncratic risk and much less from common factor risk. Much of the work done on the differences between the risk properties of retail, SME and corporate credit has been based on parameterized models of credit risk. In this paper we present new quantitative evidence on the implied credit loss distributions for two Swedish banks using a non-parametric Monte Carlo re-sampling method following Carey [1998]. Our results are based on a panel data set containing both loan and internal rating data from the banks’ complete business loan portfolios over the period 1997-2000. We compute the credit loss distributions that each rating system implies and compare the required economic capital implied by these loss distributions with the regulatory capital under Basel II. By exploiting the fact that a subset of all businesses in the sample is rated by both banks, we can generate loss distributions for SME, retail and corporate credit portfolios with a constant risk profile. Our findings suggest that a special treatment for retail credit and SME loans may not be justified. We also investigate if any alternative definition of SME’s and retail credit would warrant different risk weight functions for these types of exposure. Our results indicate that it may be difficult to find a simple risk weight function that can account for the differences in portfolio risk properties between banks and asset types.

Suggested Citation

  • Jacobson, Tor & Lindé, Jesper & Roszbach, Kasper, 2004. "Credit Risk versus Capital Requirements under Basel II: Are SME Loans and Retail Credit Really Different?," Working Paper Series 162, Sveriges Riksbank (Central Bank of Sweden).
  • Handle: RePEc:hhs:rbnkwp:0162
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    References listed on IDEAS

    as
    1. Gordy, Michael B., 2000. "A comparative anatomy of credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 119-149, January.
    2. Carling, Kenneth & Jacobson, Tor & Linde, Jesper & Roszbach, Kasper, 2007. "Corporate credit risk modeling and the macroeconomy," Journal of Banking & Finance, Elsevier, vol. 31(3), pages 845-868, March.
    3. Mark Carey, 2000. "Dimensions of Credit Risk and Their Relationship to Economic Capital Requirements," NBER Working Papers 7629, National Bureau of Economic Research, Inc.
    4. Carling, Kenneth & Jacobson, Tor & Lindé, Jesper & Roszbach, Kasper, 2002. "Capital Charges under Basel II: Corporate Credit Risk Modelling and the Macro Economy," Working Paper Series 142, Sveriges Riksbank (Central Bank of Sweden).
    5. Dietsch, Michel & Petey, Joel, 2002. "The credit risk in SME loans portfolios: Modeling issues, pricing, and capital requirements," Journal of Banking & Finance, Elsevier, vol. 26(2-3), pages 303-322, March.
    6. Jacobson, Tor & Linde, Jesper & Roszbach, Kasper, 2006. "Internal ratings systems, implied credit risk and the consistency of banks' risk classification policies," Journal of Banking & Finance, Elsevier, vol. 30(7), pages 1899-1926, July.
    7. Perli, Roberto & Nayda, William I., 2004. "Economic and regulatory capital allocation for revolving retail exposures," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 789-809, April.
    8. Carey, Mark & Hrycay, Mark, 2001. "Parameterizing credit risk models with rating data," Journal of Banking & Finance, Elsevier, vol. 25(1), pages 197-270, January.
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    13. Mark S. Carey, 2000. "Dimensions of credit risk and their relationship to economic capital requirements," Finance and Economics Discussion Series 2000-18, Board of Governors of the Federal Reserve System (U.S.).
    14. Mitchell A. Petersen & Raghuram G. Rajan, 2002. "Does Distance Still Matter? The Information Revolution in Small Business Lending," Journal of Finance, American Finance Association, vol. 57(6), pages 2533-2570, December.
    15. Dietsch, Michel & Petey, Joel, 2004. "Should SME exposures be treated as retail or corporate exposures? A comparative analysis of default probabilities and asset correlations in French and German SMEs," Journal of Banking & Finance, Elsevier, vol. 28(4), pages 773-788, April.
    16. Paul S. Calem & Michael LaCour-Little, 2001. "Risk-based capital requirements for mortgage loans," Finance and Economics Discussion Series 2001-60, Board of Governors of the Federal Reserve System (U.S.).
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    18. Dennis Glennon & Peter Nigro, 2005. "An Analysis of SBA Loan Defaults by Maturity Structure," Journal of Financial Services Research, Springer;Western Finance Association, vol. 28(1), pages 77-111, October.
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    Keywords

    Internal ratings; Credit risk; Value-at-Risk; Banks; Basel II; Retail credit; SME; risk weights;

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • 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
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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