A Model of Bank Reserves with Macroeconomic and Financial Corrections

The publication of the second document on bank regulation by the Bank for International Settlements (BIS) paved the way for banking institutions to develop increasingly complex models for the calculation of their capital requirements as a protection measure against credit risk. The Internal Ratings Based (IRB) Models were classified in simple and advanced depending on the parameters to be estimated by the entity and those determined by the regulator. The default rate and the loss given default parameters must be calculated internally for the model to be deemed as advanced. The model presented here leaves aside a priori considerations and establishes default rates based on historical information. On the other hand, rather than homogenizing credit categories, it has been assumed that there is internal variability in the default rates within the same stratum. Finally, these rates were corrected by means of a proportional risks model to reflect the economic situation and to allow the entity to keep an amount of reserves consistent with default expectations. The model was simulated once these facts were properly considered, and the result was an estimation of the portfolio average loss and, consequently, of the reserves ratio.