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Cyclicality in Losses on Bank Loans

Bart Keijsers, Bart Diris and Erik Kole ()
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Bart Diris: Erasmus University Rotterdam, the Netherlands

No 15-050/III, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: Based on unique data we show that macro variables, the default rate and loss given default of bank loans share common cyclical components. The innovation in our model is the distinction between loans with either severe or mild losses. The variation in the proportion of these two types drives the cyclic behavior of the loss given default, and constitutes the links with the default rate and macro variables. These links vary according to loan and borrower characteristics. During downturns, the proportion of defaults with severe losses increases, but the distribution of losses conditional on their being mild or severe does not change. Though loans are monitored more closely than bonds and are more senior, the cyclical variation in their losses resembles those for bonds, albeit around a lower average level. This variation leads to an increase in the capital reserves required for loan portfolios.

Keywords: Loss-given-default; default rates; credit risk; capital requirements; dynamic factor models (search for similar items in EconPapers)
JEL-codes: C32 C58 G21 G33 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-rmg
Date: 2015-05-04, Revised 2017-04-18
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