We present a model of risky debt in which collateral value is correlated with the possibility of default. The model is then used to study: 1) the expected amount of debt recovered in the event of default as a function of collateral; and 2) the amount of collateral needed to mitigate the...

The rating-sensitive capital charges on credit risks under the new Basel Accord are likely to increase the volatility of minimum capital requirements, which may force banks to hold larger capital cushions in excess of minimum requirements. We analyse this claim on the basis of numerical...

The rating-sensitive capital charges on credit risks under the new Basel Accord are likely to increase the volatility of minimum capital requirements, which may force banks to hold larger capital cushions in excess of minimum requirements.We analyse this claim on the basis of numerical...

Building on the work of Sorge and Virolainen (2006), we revisit the data on aggregate Finnish bank loan losses from the corporate sector, which covers the ‘Big Five’ crisis in Finland in the early 1990s. Several extensions to the empirical model are considered. These extensions are then used...

Although beneficial allocational effects have been a central motivator for the Basel II capital adequacy reform, the interaction of these effects with Basel II’s procyclical impact has been less discussed. In this paper, we investigate the effect of capital requirements on the allocation of...

Basel II framework requires banks to conduct stress tests on their potential future minimum capital requirements and consider ‘at least the effect of mild recession scenarios’. We propose a stress testing framework for minimum capital requirements in which banks’ corporate credit risks are...

Although beneficial allocational effects have been a central motivation for the Basel II capital adequacy reform, the interaction of these effects with Basel II’s procyclical impact has been less discussed. In this paper, we investigate the effect of Basel II on the efficiency of bank lending....

We study the effects on credit allocation and bank stability of introducing a leverage ratio requirement (LRR) on top of risk-based capital requirements, as in Basel III. For the current 3% LRR, both low-risk and high-risk loan rates and volumes remain essentially unchanged, because banks...

We show how banks’ excessive risk-taking, stemming from informational asymmetries in loan markets, can lead to an excessive output loss when a recession starts. Risk-based capital requirements can alleviate the output loss by reducing excessive risk-taking in ‘normal’ times. Model...

Basel III has introduced a non-risk-weighted leverage ratio requirement (LRR) which complements the internal ratings based (IRB) capital requirements. It provides a backstop against model risk which arises if some loans get incorrectly rated and become toxic. We study the effects of the LRR on...