Cross-border loan portfolio diversification, capital requirements, and the European Banking Union

Esa Jokivuolle () and Matti Virén

No 3/2019, BoF Economics Review from Bank of Finland

Abstract: We provide preliminary evidence of potential risk reduction benefits from banks’ loan portfolio diversification cross-border within the Euro area. Using aggregate data on banking sector cor-porate loan losses for each Euro area member-state, our estimates suggest that the static diversification benefit could be substantial. The minimum capital needed to withstand the max-imum annual loss from a hypothetical fully diversified Euro area bank loan portfolio over the period 2001-2017 would have been only 40 % of the total capital needed to withstand the maximum losses on a country by country basis. We also calibrate the country-specific loan loss distributions and the Euro area portfolio’s loss distribution to the Vasicek (2002) model, which underlies the Basel framework’s Internal Ratings Based Approach. We find that the im-plied asset correlation parameter of a median country portfolio is about twice as large as that of the fully diversified Euro area portfolio.

Keywords: pankit; luotot; euroalue (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-ban, nep-eec and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:bofecr:32019

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