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Granularity Adjustment for Regulatory Capital Assessment

Author

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  • M. B. Gordy

    (Federal Reserve Board)

  • E. Lutkebohmert

    (University of Freiburg)

Abstract

The credit value-at-risk model underpinning the internal ratings-based approach of Basel II and III assumes that idiosyncratic risk has been fully diversified in the portfolio, so that economic capital depends only on systematic risk contributions. We propose a simple granularity adjustment (GA) for approximating the effect of undiversified idiosyncratic risk on required capital. To mitigate operational burden in implementation, we derive upper and lower bounds on the GA under incomplete information on the portfolio. We assess the magnitude and accuracy of the proposed GA on a set of bank portfolios drawn from the German credit register.

Suggested Citation

  • M. B. Gordy & E. Lutkebohmert, 2013. "Granularity Adjustment for Regulatory Capital Assessment," International Journal of Central Banking, International Journal of Central Banking, vol. 9(3), pages 38-77, September.
    • Handle: RePEc:ijc:ijcjou:y:2013:q:3:a:2
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    Cited by:

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    2. Paul H. Kupiec, 2015. "Portfolio diversification in concentrated bond and loan portfolios," AEI Economics Working Papers 837343, American Enterprise Institute.
    3. Álvaro Chamizo & Alexandre Fonollosa & Alfonso Novales, 2019. "Forward-looking asset correlations in the estimation of economic capital," Documentos de Trabajo del ICAE 2019-25, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    4. Regele, Fabian & Gründl, Helmut, 2021. "Asset concentration risk and insurance solvency regulation," ICIR Working Paper Series 40/21, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    5. Kupiec, Paul, 2015. "Capital for concentrated credit portfolios," Journal of Risk Management in Financial Institutions, Henry Stewart Publications, vol. 8(4), pages 314-322, October.
    6. Chris Humphrey, 2017. "He who pays the piper calls the tune: Credit rating agencies and multilateral development banks," The Review of International Organizations, Springer, vol. 12(2), pages 281-306, June.
    7. Caccioli, Fabio & Shrestha, Munik & Moore, Cristopher & Farmer, J. Doyne, 2014. "Stability analysis of financial contagion due to overlapping portfolios," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 233-245.
    8. Annalisa Di Clemente, 2020. "Modeling Portfolio Credit Risk Taking into Account the Default Correlations Using a Copula Approach: Implementation to an Italian Loan Portfolio," JRFM, MDPI, vol. 13(6), pages 1-24, June.
    9. Rainer Masera, 2014. "CRR/CRD IV: the trees and the forest," PSL Quarterly Review, Economia civile, vol. 67(271), pages 381-422.
    10. Jens Fittje, 2023. "Risk-shifting, concentration risk, and heterogeneous borrowers," International Economics and Economic Policy, Springer, vol. 20(4), pages 509-536, October.
    11. Chamizo, Álvaro & Fonollosa, Alexandre & Novales, Alfonso, 2019. "Forward-looking asset correlations in the estimation of economic capital," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 61(C), pages 264-288.
    12. Henry Penikas, 2023. "Default correlation impact on the loan portfolio credit risk measurement for the "green" finance as an example," Bank of Russia Working Paper Series wps121, Bank of Russia.
    13. Jan Nokkala, 2022. "Are large credit exposures a source of concentration risk?," Bank i Kredyt, Narodowy Bank Polski, vol. 53(4), pages 375-398.
    14. Neumann, Tobias, 2018. "Mortgages: estimating default correlation and forecasting default risk," Bank of England working papers 708, Bank of England.
    15. Pierpaolo Grippa & Lucyna Gornicka, 2016. "Measuring Concentration Risk - A Partial Portfolio Approach," IMF Working Papers 2016/158, International Monetary Fund.

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    More about this item

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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