Skewness of Returns, Capital Adequacy, and Mortgage Lending
We calibrate a simulation model of credit value-at-risk for mortgage lending to UK experience. Simulations to capture the skewness of returns that might arise in the context of a financial crisis suggest that the IRB calculations of the new Basel Accord can substantially understate prudential capital adequacy. The same model shows that raising capital requirements has only a small impact on bank funding costs. We conclude that Pillar 2 supervisory review should increase capital requirements above IRB levels for secured bank assets - those whose returns can potentially fall furthest, relative to other, normally "riskier" assets, in extreme outcomes.
DIMOU Paraskevi;
LAWRENCE Colin;
MILNE Alistair;
2006-03-09
Springer Science + Business Media B.V.
JRC32215
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