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Forecasting and Stress-testing the Risk-based Capital Requirements for Revolving Retail Exposures

Author

Listed:
  • Dunbar, Kwamie

    () (John F. Welch College of Business, Sacred Heart University)

Abstract

This paper presents a tractable and empirically sound technique for generating stressed probabilities of default (PDs) which are then used to derive loss rates for the provisioning of a bank’s risk-based capital. This work is in response to the recent regulatory findings attributed to the Supervisory Capital Assessment Program (SCAP) stress tests of 2009 which revealed weaknesses in the existing regulatory and economic capital approaches. The SCAP projected losses of approximately $82.4 Billion in banks’ credit card portfolios for 2010, highlighting the need for better forecasting and stress testing of revolving retail exposures. This study proposes a timely model that will improve the ability of banks to determine the capital adequacy of revolving retail exposures. Using options theory we discuss why an obligor may default and produce estimates of expected losses from our stressed PDs so as to determine loss provisions. This method relies on the simulation of PD distributions via changes in selected macroeconomic variables and the card holder’s debt to income ratio (DTIR). The methodology offers the flexibility of being tractable and scalable to data in the issuer’s credit card portfolio by geography and credit quality of the obligor.

Suggested Citation

  • Dunbar, Kwamie, 2012. "Forecasting and Stress-testing the Risk-based Capital Requirements for Revolving Retail Exposures," Working Papers 2012001, Sacred Heart University, John F. Welch College of Business.
  • Handle: RePEc:she:wpaper:2012001
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    File URL: http://repec.sacredheart.edu/she/pdf/wp2012_001.pdf
    File Function: First version, 2012
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    References listed on IDEAS

    as
    1. Edward S. Knotek & II, 2007. "How useful is Okun's law?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 73-103.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Capital Requirement; Stress-test; capital adequacy;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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