Loan Pricing Under Basel Capital Requirements

Rafael Repullo and Javier Suarez

No 3917, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We analyse the implications for the pricing of bank loans of the reform of capital regulation known as Basel II. We consider a perfectly competitive market for business loans where, as in the model underlying the internal ratings based (IRB) approach of Basel II, a single risk factor explains the correlation in defaults across firms. Our loan pricing equation implies that low-risk firms will achieve reductions in their loan rates by borrowing from banks adopting the IRB approach, while high-risk firms will avoid increases in their loan rates by borrowing from banks that adopt the less risk-sensitive standardized approach of Basel II. We also show that only an extremely high social cost of bank failure might justify the proposed IRB capital charges for high-risk loans, partly because the margin income from performing loans is not counted as a buffer against credit losses, and we propose a margin income correction for IRB capital requirements.

Keywords: Bank regulation; Capital requirements; Credit risk; Internal ratings; Loan defaults; Margin income (search for similar items in EconPapers)
JEL-codes: E43 G21 G28 (search for similar items in EconPapers)
Date: 2003-05
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Related works:
Journal Article: Loan pricing under Basel capital requirements (2004)
Working Paper: Loan Pricing Under Basel Capital Requirements (2003)
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