Stress testing of real credit portfolios

Stress testing has become a crucial point on the Basel II agenda, mainly as Pillar I estimates do not explicitly take portfolio concentration into account. We start from the credit portfolio of the German pension insurer being a cross-sectional representation of the German economy and subsequently compose three bank portfolios corresponding to a small, medium and large bank. We apply univariate and multivariate stress tests both by using the Internal Rating based (IRB) model and by a model that additionally allows for variation of correlation. In a severe multivariate stress scenario based on historical data for Germany IRB capital requirements increase by more than 80% with little differences between the credit portfolios. If stress testing is additionally applied to correlation, the Value-at-Risk increases by up to 300% and portfolio differences materialize. --Credit Portfolio,Exposure concentration,Stress Testing,Basel II,Economic Capital

Stress Testing Credit Risk: Is the Czech Republic Different from Germany?

This study deals with credit risk modelling and stress testing within the context of a Merton-type one-factor model. We analyse the corporate and household sectors of the Czech Republic and Germany to find determining variables of credit risk in both countries. We find that a set of similar variables explains corporate credit risk in both countries despite substantial differences in the default rate pattern. This does not apply to households, where further research seems to be necessary. Next, we establish a framework for the stress testing of credit risk. We use a country specific stress scenario that shocks macroeconomic variables with medium severity. The test results in credit risk increasing by more than 100% in the Czech Republic and by roughly 40% in Germany. The two outcomes are not fully comparable since the shocks are calibrated according to the historical development of the time series considered and the size of the shocks for the Czech Republic was driven by the transformation period.Credit risk, credit risk modelling, stress testing.

Modelling dynamic portfolio risk using risk drivers of elliptical processes

The situation of a limited availability of historical data is frequently encountered in portfolio risk estimation, especially in credit risk estimation. This makes it, for example, difficult to find temporal structures with statistical significance in the data on the single asset level. By contrast, there is often a broader availability of cross-sectional data, i.e., a large number of assets in the portfolio. This paper proposes a stochastic dynamic model which takes this situation into account. The modelling framework is based on multivariate elliptical processes which model portfolio risk via sub-portfolio specific volatility indices called portfolio risk drivers. The dynamics of the risk drivers are modelled by multiplicative error models (MEM) - as introduced by Engle (2002) - or by traditional ARMA models. The model is calibrated to Moody's KMV Credit Monitor asset returns (also known as firm-value returns) given on a monthly basis for 756 listed European companies at 115 time points from 1996 to 2005. This database is used by financial institutions to assess the credit quality of firms. The proposed risk drivers capture the volatility structure of asset returns in different industry sectors. A characteristic temporal structure of the risk drivers, cyclical as well as a seasonal, is found across all industry sectors. In addition, each risk driver exhibits idiosyncratic developments. We also identify correlations between the risk drivers and selected macroeconomic variables. These findings may improve the estimation of risk measures such as the (portfolio) Value at Risk. The proposed methods are general and can be applied to any series of multivariate asset or equity returns in finance and insurance. --Portfolio risk modelling,Elliptical processes,Credit risk,multiplicative error model,volatility clustering

RELATIONSHIP LENDING - EMPIRICAL EVIDENCE FOR GERMANY

Relationship lending is a common practice in credit financing all over the world, notably also in the European Union, which has been assumed to be particularly beneficial for Small and Medium-Sized Enterprises (SMEs). During recent years, there has been the impression that relationship lending loses ground due to a change of the banks' business models, which could ultimately yield to a worsening of the business environment for corporates and SMEs. In this study, we investigate the determinants of relationship lending for Germany, where relationship lending traditionally plays an important role. Compared to previous studies, we refer to much more comprehensive data with information on more than 16,000 firm-bank relationships. Our findings confirm the assumption that relationship lending seems to be an important pillar for economic growth and employment: We find that the firms that are most likely to contribute to (future) economic growth, namely small and R&D-intensive firms, tend to choose a relationship lender. The same is observed for firms of high credit quality, independent of their size or R&D intensity. Furthermore, we also observe that the importance of relationship lending did not decrease since the mid 1990s.Relationship banking; German banking system; SME

Asset correlations and credit portfolio risk: an empirical analysis

In credit risk modelling, the correlation of unobservable asset returns is a crucial component for the measurement of portfolio risk. In this paper, we estimate asset correlations from monthly time series of Moody's KMV asset values for around 2,000 European firms from 1996 to 2004. We compare correlation and value-atrisk (VaR) estimates in a one-factor or market model and a multi-factor or sector model. Our main finding is a complex interaction of credit risk correlations and default probabilities affecting total credit portfolio risk. Differentiation between industry sectors when using the sector model instead of the market model has only a secondary effect on credit portfolio risk, at least for the underlying credit portfolio. Averaging firm-dependent asset correlations on a sector level can, however, cause a substantial underestimation of the VaR in a portfolio with heterogeneous borrower size. This result holds for the market as well as the sector model. Furthermore, the VaR of the IRB model is more stable over time than the VaR of the market model and the sector model, while its distance from the other two models fluctuates over time. --Asset correlations,sector concentration,credit portfolio risk

Relationship lending: empirical evidence for Germany

Relationship lending is a common practice in credit financing all over the world, particularly in Germany. On the basis of a comprehensive data set comprising information on firm-bank relationships for more than 16,000 observations, this study analyses the determinants of relationship lending in Germany. We find that small, young and R&D-intensive firms tend to choose relationship lending. Furthermore, we find that firms with a higher creditworthiness are more likely to choose a relationship lender. We find that the importance of relationship lending stayed roughly constant since the mid 90s. --Relationship banking,German banking system,SME

Empirical risk analysis of pension insurance: the case of Germany

With this paper we seek to contribute to the literature on pension insurance systems. The financial literature tends to focus exclusively on the US pension insurance system. This is the first major empirical study to address the German occupational pension insurance (PSVaG) plan in Germany. The study is based on a Merton-type one-factor model, in which we determine the credit portfolio risk profile of the occupational pension insurance plan and compare two alternative pricing plans. We find that there is a low, yet non-negligible risk of very high losses that may threaten the existence of the occupational pension insurance plan (PSVaG). While relating risk premiums to firms' default probabilities would cause them to diverge widely, a marginal risk contribution method would produce less pronounced differences compared to the current, uniform pricing plan. --Pension insurance,Risk-adjusted premiums,Credit portfolio risk

Banking consolidation and small businessfinance: empirical evidence for Germany

Since the early 1990s an unprecedented process of consolidation has taken place in the banking sector in most industrialised countries raising concern of policymakers that it may reduce access to credit for the small business sector. While most of the existing empirical studies have focused on the U.S., this paper is the first one empirically investigating the effects of banking consolidation in Germany. As small and medium sized German companies traditionally almost exclusively rely on bank credit and as they represent the vast majority of the corporate sector reduced credit availability for those companies could particularly endanger economic growth. Based on an exceptional panel dataset comprising merged data of the German credit register and balance sheet data of German firms and banks we find - contrary to public fear - that the ongoing banking consolidation in Germany does not have a significant negative impact on the financing of small and medium-sized enterprises (SME). We measure the financing opportunities of SMEs based on the bank debt/assets ratio and the logarithmized credit size and control both explicitly for bank mergers and for the increase in the average bank size in the course of the consolidation process. In addition, we observe that the concentration in the banking market is insignificant for SME financing and that there is no significant difference between commercial banks, savings banks and private banks. --Banking consolidation,bank mergers,SME financing

EIB Working Papers 2019/11 - Macro-based asset allocation

Macro-based asset allocation is based on the identification of turning points in macro-financial cycles. This paper suggests that macro-based asset allocation informed by trends in continuous business and financial cycle indicators could be a promising alternative for medium- and long-term investment strategies. Despite changes during the last three decades, the most promising specifications of this approach did roughly anticipate turning points in asset price cycles, implying favourable returns and low portfolio volatility

Readying Extension for the Systematic Analysis of Large Qualitative Data Sets

Land-grant Extension institutions face increasing expectations to use data to communicate value and drive program and organizational development. In this article, we introduce the University of Wisconsin–Extension Data Jam Initiative, an integrated qualitative software, methods, and data analysis curriculum. The Data Jam Initiative is an evaluation capacity building framework for collaborative, mentorship-based analysis sessions across an institution and across disciplines. Through sharing exemplar applications of this curriculum, we illustrate how the Data Jam Initiative prepares Extension institutions for using qualitative data in service of communication to stakeholders, program development, and organizational growth