Volume 11, Number 1, June 2016
| Analyzing Downturn Loss Given Default |
Abstract
Under Basel II and Basel III accords, banks can use Internal-Rating-Based (IRB) approach to estimate their own loss given default (LGD). They need to consider a downturn LGD provided by Basel Committee on Banking Supervision (BCBS) to address unexpected loss under the foundation IRB approach. Comparing our measure with the LGD of Basel foundation IRB approach (BLGD), we find DLGD of Taiwan’s companies are much lower than BLGD. This strict regulatory standard may lead to higher capital used and reduce more lending activities for Taiwan's bank sectors. We also verify the characteristic on DLGD by using the macro-factor and probability of default and obtain significant results. These research results not only calibrate LGD to past economic downturns but also build more accurate credit risk pricing for advanced Internal Rating Based (IRB).
Keywords: Downturn LGD; Default Probability; Basel Accord; Recovery Rate
JEL Classification: G3, G33