Exposure at Default Model for Contingent Credit Line

Bag, Pinaki (2010): Exposure at Default Model for Contingent Credit Line.

Abstract

In-spite of large volume of Contingent Credit Lines (CCL) in all commercial banks paucity of Exposure at Default (EAD) models, unsuitability of external data and inconsistent internal data with partial draw-down, has been a major challenge for risk managers as well as regulators for managing CCL portfolios. Current paper is an attempt to build an easy to implement, pragmatic and parsimonious yet accurate model to determine exposure distribution of a CCL portfolio. Each of the credit line in a portfolio is modeled as a portfolio of large number of option instrument which can be exercised by the borrower determining the level of usage. Using an algorithm similar to basic CreditRisk+ and Fourier Transforms we arrive at a portfolio level probability distribution of usage.

• Item Type: MPRA Paper
• Language: English
• Keywords: EAD, Basel II, Credit Risk, Contingent credit line (CCL)
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C13 - Estimation: General; G - Financial Economics > G2 - Financial Institutions and Services > G21 - Banks ; Depository Institutions ; Micro Finance Institutions ; Mortgages; G - Financial Economics > G2 - Financial Institutions and Services > G20 - General

References

[1]Agarwal, S., and Ambrose, B. “Credit lines and credit utilization.” Journal of Mon-ey, Credit and Banking 38(1) (2006): 1–22.

[2]Akkaya, N., Kurth, A. and Wagner, A. “Incorporating default correlations and severity variations” in M. Gundlach and F. Lehrbass [13]

[3]Araten, Michel and Michael Jacobs, Jr. “Loan Equivalents for Revolving Credits and Advised Lines.” The RMA Journal, (2001): 34-39.

[4]Asarnow, E. and Marker, E. “Historical Performance of the U.S. Corporate Loan Market: 1988-1993,” Commercial Lending Review, 10(2), (1995): 13-32.

[5]Avery, Robert B., and Alan N. Berger. “Loan Commitments and Bank Risk Expo-sure.” Journal of Banking and Finance 15, (1991):173–192

[6]Basel Committee of Banking Supervision, “Basel II: International convergence of capital measurement and capital standards: a revised framework.” Available at www.bis.org/publ/bcbs118.htm, 19 Nov. 2009.

[7]Board of Governors of the Federal Reserve System, (2009) “Survey of Terms of Business Lending.” Federal Reserve Board Statistical Releases, E.2 Available at http://www.federalreserve.gov/releases/e2/current/default.htm, 21 Nov. 2009

[8]Chateau, John Peter D and Jian Wu (2004) “Basle II Capital Adequacy: Comput-ing the 'Fair' Capital Charge for Loan Commitment 'True' Credit Risk.” EFMA 2004 Basel Meetings Paper. Available at SSRN: http://ssrn.com/abstract=497546

[9]Château., John-Peter D. "Valuation of ‘capped’ variable rate loan commitments" Journal of Banking & Finance Volume 14, Issue 4, (1990):717-728

[10]Credit Suisse, (1997). CreditRisk+: A Credit Risk Management Framework. Credit Suisse Financial Products. Available at www.csfb.com/creditrisk, 1997.

[11]Crouhy, M., D. Galai, and R. Mark. “A Comparative Analysis of Current Credit Risk Models.” Journal of Banking and Finance 24 (2000):59–118.

[12]Ergungor, Ozgur E., 2001, Theories of bank loan commitments: A literature re-view, Federal Reserve Bank of Cleveland Economic Review 37, 2-19.

[13]Monniaux, David., “The pitfalls of verifying floating-point computations.” TOPLAS, (2008)

[14]M. Gundlach and F. Lehrbass (eds.), CreditRisk+ in the Banking Industry, Springer-Verlag, Berlin, Heidelberg, 2004.

[15]D. Karlis and E. Xekalaki, “Mixed Poisson distributions,” International Statistical Review, vol. 73, no. 1, (2005):35–58

[16]Federal Deposit Insurance Corporation, Statistics on Banking, (2009) table RC-6 Available at http://www2.fdic.gov/SDI/main4.asp

[17]Financial Services Authority, UK. Comments on EAD models (2007). EAD Expec-tation Note. Available at http://www.fsa.gov.uk/pubs/international/ead_models.pdf

[18]Gatev, Evan and Philip Strahan, “Banks Advantage in Hedging Liquidity Risk: Theory and Evidence from the Commercial Paper Market.” Journal of Finance 61, (2006):867-892.

[19]Gordy, M. B., “A Comparative Anatomy of Credit Risk Models.” Journal of Banking and Finance 24 (2000):119–149.

[20]Hull, J., “Assessing Credit Risk in a Financial Institution’s Off-Balance Sheet Com-mitments.” Journal of Financial and Quantitative Analysis, 24(4), (1989): 489-501.

[21]Jacobs, M., Jr., “An Empirical Study of Exposure at Default,” Manuscript, Office of the Comptroller of the Currency, U.S. Department of the Treasury. (2008)

[22]Jimenez, Gabriel, Jose A. Lopez, and Jesus Saurina, “Empirical analysis of corpo-rate credit lines”, Working Paper, Banco de Espana and Federal Reserve Bank of San Francisco.(2008)

[23]Jones, Robert, Yan Wendy Wu Analyzing credit lines with fluctuating credit quality. Working Paper, The Bank of Canada - Simon Fraser University Conference on Financial Market Stability. (2009)

[24]Kanatas, George., ”Commercial Paper, Bank Reserve Requirements, and the In-formational Role of Loan Commitments.” Journal of Banking and Finance 11, (1987):425–448

[25]Kaplan, Steven and Luigi Zingales “Do Investment-Cash Flow Sensitivities Pro-vide Useful Measures of Financing Constraints?” Quarterly Journal of Economics 112, (1997):169-215.

[26]Loukoianova, Elena., Salih N. Neftci, and Sunil Sharma “Pricing and Hedging of Contingent Credit Lines ,”IMF Working Paper,WP/06/13, (2006)

[27]M. Leippold, S. Ebnoether, P. Vanini, “Optimal Credit Limit Management,” National Centre of Competence in Research Financial Valuation and Risk Management, Working Paper No. 72. (2003)

[28]Maksimovic, V. “Product Market Imperfections and Loan Commitments,” Journal of Finance, vol. 45 (1990), pp. 1641–54.

[29]Martin., J. Spencer and Anthony M. Santomero “Investment opportunities and cor-porate demand for lines of credit, ”Journal of Banking & Finance, Volume 21, Issue 10, (1997):1331-1350

[30]Melchiori, Mario R., “CreditRisk+ by Fast Fourier Transform,” YieldCurve, August 2004. Available at SSRN: http://ssrn.com/abstract=1122844

[31]Miu, P., and B. Ozdemir., Basel II Implementation: A Guide to Developing and Vali-dating a Compliant Internal Risk Rating System, McGraw-Hill Professional, (2008): 173.

[32]Moral, G., “EAD Estimates for Facilities with Explicit Limits” in Engelmann, B. and Rauhmeier, R., eds. The Basel II Risk Parameters: Estimation, Validation, and Stress Testing. New York: Springer, (2006):197-242.

[33]Qi, M., “Exposure at Default of Unsecured Credit Cards”, Credit Risk Analysis Di-vision, Office of the Comptroller of the Currency, 250 E St. SW, Washington, DC 20219; (2009)

[34]RMA – The Risk Management Association (2004) Industry Practices in Estimating EAD and LGD for Revolving Consumer Credits – Cards and Home Equity Lines of Credit. Available at http://www.rmahq.org/../RMA_EAD_LGD_Survey_Paper_FINAL.pdf

[35]Robertson, J., “The Computation of Aggregate Loss Distributions,” PCAS LXXIX, (1992): 57–133.

[36]Rosen, D., and M. Sidelnikova, “Understanding Stochastic Exposures and LGD’s in Portfolio Credit Risk”, Algo Research Quaterly, Vol. 5, N° 1, (2002):43-56.

[37]Sufi, Amir. “Bank Lines of Credit in Corporate Finance: An Empirical Analysis.” The Review of Financial Studies, Vol. 22, Issue 3, (2009):1057-1088

[38]Thakor, Anjan V., Hai Hong and Stuart I. Greenbaum, "Bank Loan Commitments and Interest Rate Volatility," Journal of Banking and Finance, Vol. 5, (1981):497-510.

[39]Thakor, Anjan V., and G.F. Udell. “An Economic Rationale for the Pricing Structure of Bank Loan Commitments,” Journal of Banking and Finance, vol. 11 (1987), pp. 271–89.