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The Basel Committee Approach To Risk-Weights And External Ratings: What Do We Learn From Bond Spreads?

Author

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  • Andrea Resti

    (University of Milan L. Bocconi)

  • Andrea Sironi

    (University of Milan L. Bocconi)

Abstract

The Basel Committee for Banking Supervision designed a system of risk weights (the so called standardised approach) to measure the riskiness of banks� loan portfolios. Its ability to adequately reflect risk is empirically investigated in this paper, through an analysis of the economic capital allocations implied in corporate bond spreads. This is based on a unique dataset of issuance spreads, ratings and other relevant bond variables (such as maturity, face value, time of issuance and currency of denomination) including 7,232 eurobonds issued mostly by Canadian, European, Japanese and U.S. companies during 1991-2003. Three main results emerge. First, the spread/rating relationship is strongly significant with spreads increasing when ratings worsen. Second, the estimated spreads per rating class indicate that the risk/rating relationship might be steeper than the one approved by the Basel Committee. Finally the difference between the spread/rating relation of banks and non-financial firms appears quite blurred and statistically questionable. Following this empirical evidence, we underline some adjustments in the standardised approach risk-weights that might be considered for the future versions of the Basel Accord.

Suggested Citation

  • Andrea Resti & Andrea Sironi, 2005. "The Basel Committee Approach To Risk-Weights And External Ratings: What Do We Learn From Bond Spreads?," Temi di discussione (Economic working papers) 548, Bank of Italy, Economic Research and International Relations Area.
    • Handle: RePEc:bdi:wptemi:td_548_05
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    References listed on IDEAS

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    Cited by:

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    2. Gonzalez, F. & Haas, F. & Johannes, R. & Persson, M. & Toledo, L. & Violi, R. & Zins, C. & Wieland, M., 2004. "Market dynamics associated with credit ratings: a literature review," Financial Stability Review, Banque de France, issue 4, pages 53-76, June.
    3. Ueda, Kenichi & Weder di Mauro, B., 2013. "Quantifying structural subsidy values for systemically important financial institutions," Journal of Banking & Finance, Elsevier, vol. 37(10), pages 3830-3842.
    4. Richard Davies & Belinda Tracey, 2014. "Too Big to Be Efficient? The Impact of Implicit Subsidies on Estimates of Scale Economies for Banks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(s1), pages 219-253, February.
    5. Patricia Palhau Mora, 2018. "The “Too Big to Fail” Subsidy in Canada: Some Estimates," Staff Working Papers 18-9, Bank of Canada.
    6. Abaffy, J. & Bertocchi, M. & Dupacova, J. & Moriggia, V. & Consigli, G., 2007. "Pricing nondiversifiable credit risk in the corporate Eurobond market," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2233-2263, August.

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    More about this item

    Keywords

    eurobonds; credit ratings; spreads; capital regulation; banks.;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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