Capital Allocation and Bank Management Based on the Quantification of Credit Risk

Abstract

Credit rating transition probability Correlation coefficient •Between industries •Between customers Database Transaction data Collateral cover Customer data Rating assignment Monte Carlo simulation Generation of 10,000 scenarios covering the whole maturity Characteristics 1) Simulation of credit rating transition 2) Taking account of correlation Model for the Quantification of Credit Risk Measurement of expected loss/maximum loss 1) Expected loss: average of the 10,000 outcomes 2) Maximum loss: 99 percent confidence interval Credit risk delta Applied to the risk analysis for: • Bank as a whole • Each business area • Each branch • Each customer Allocated capital to cover risk Risk-adjusted return of equity (integrated ROE)

Bank capital allocation under multiple constraints

“…1 As discussed in Guill [2016], the origin of many risk management practices can be traced back to approaches pioneered by Bankers Trust starting from the mid-1970s. Practical applications of these concepts are discussed in, for example, James [1996], Zaik et al [1996], Nishiguchi et al [1998] or Ita [2016].…”

Monte Carlo Simulation of Economic Capital Requirement & Default Protection Premium

“…However, the received literature has mainly been located in the context of developed economies. See for example, Koyluoglu, Hickman (1998), Nishiguchi, Kawai, Sazaki(1998), Jones and Mingo(1998), Ong (1999), Finger (1999), Schönbucher (2000), Wilde (2001) and Xiao (2002) for calibration of economic capital requirement. Similar studies undertaken within emerging economies are virtually non-existent.…”