Purpose – The IRB capital requirements of Basel II define the minimum level of capital that the bank has to retain to cover the current risks of its portfolio. The major risk that many banks are facing is credit risk and Basel II provides an approach to calculate its capital requirement. It is well known that Pillar I Basel II approach for credit risk capital requirements does not include concentration risk. The paper aims to propose a model modifying Basel II methodology (IRB) to include name concentration risk. Design/methodology/approach – The model is developed on data based on a portfolio of Greek companies that are financed by Greek commercial banks. Based on the initial portfolio, new portfolios were simulated having a range of different credit risk parameters. Subsequently, the credit VaR of various portfolios was regressed against the credit risk indicators such as Basel II capital requirements, modified Herfindahl Index and a non‐linear model was developed. This model modifies the Pillar I IRB capital requirements model of Basel II to include name concentration risk. Findings – As the Pillar I IRB capital requirements model of Basel II does not include concentration risk, the credit VaR calculations performed in the present work appeared to have gaps with the Basel II capital requirements. These gaps were more apparent when there was high concentration risk in the credit portfolios. The new model bridges this gap providing with a correction coefficient. Practical implications – The credit VaR of a loan portfolio could be calculated from the bank easily, without the use of additional complicated algorithms and systems. Originality/value – The model is constructed in such a way as to provide an approximation of credit VaR satisfactory for business loan portfolios whose risk parameters lie within the range of those in a realistic bank credit portfolio and without the application of Monte Carlo simulations.
The Journal of Risk Finance – Emerald Publishing
Published: Jan 28, 2014
Keywords: Credit risk; Basel II; Concentration risk; Credit VaR; Herfindahl Index; IRB
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