Emerging Market Default Risk Charge Model

Author:

Joseph Angelo D.1ORCID

Affiliation:

1. School of Business Leadership, University of South Africa, Midrand, Johannesburg 2006, South Africa

Abstract

In a default event, several obligors simultaneously experience financial difficulty in servicing their debt to the point where the entire market can experience a sudden yet significant jump to a credit default. To help protect lenders against a jump-to-default event, regulators require banks to hold capital equivalent to the default risk charge as a buffer against the losses they may incur. The Basel regulatory committee has articulated and set default risk modelling guidelines to improve comparability amongst banks and enable a consistent bank-wide default risk charge estimation. Emerging markets are unique because they usually have illiquid markets and sparse data. Thus, implementing an emerging market default risk model and, at the same time, complying with the regulatory guidelines can be non-trivial. This research presents a framework for modelling the default risk charge in emerging markets in line with the regulatory requirements. The default correlation model inputs are derived and empirically calibrated using emerging market data. The paper ends with some considerations that regulators, supervisors, and banks can use to get financial institutions to adopt an emerging markets default risk charge model.

Funder

University of South Africa

Publisher

MDPI AG

Subject

Finance,Economics and Econometrics,Accounting,Business, Management and Accounting (miscellaneous)

Reference29 articles.

1. On the Inception of Sound Derivative Products in Emerging Markets, Real-world Observations and Viable Solutions;Journal of Financial Regulation and Compliance,2006

2. BCBS (2017, February 28). Revisions to the Basel II Market Risk Framework. Available online: https://www.bis.org/publ/bcbs158.pdf.

3. BCBS (2018, June 26). Guidelines for Computing Capital for Incremental Risk in the Trading Book. Available online: https://www.bis.org/publ/bcbs159.htm.

4. BCBS (2020, November 22). Reducing Excessive Variability in Banks’ Regulatory Capital Ratios. Available online: https://www.bis.org/bcbs/publ/d298.pdf.

5. BCBS (2021, February 28). Minimum Capital Requirements for Market Risk. Available online: https://www.bis.org/bcbs/publ/d352.htm.

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