Credit risk measurement and procyclicality
BIS Working Papers
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No
116
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01 September 2002
This paper examines the two-way linkages between credit risk measurement and the
macroeconomy. It first discusses the issue of whether credit risk is low or high
in economic booms. It then reviews how macroeconomic considerations are
incorporated into credit risk models and the risk measurement approach that
underlies the New Basel Capital Accord. Finally, it asks what effect these
measurement approaches are likely to have on the macroeconomy, particularly
through their role in influencing the level of bank capital. The paper argues
that much remains to be done in integrating macroeconomic considerations into
risk measurement, particularly during the upswing of business cycles that are
characterised by rapid increases in credit and asset prices. It also suggests
that a system of risk-based capital requirements is likely to deliver large
changes in minimum requirements over the business cycle, particularly if risk
measurement is based on market prices. This has the potential to increase the
financial amplification of business cycles, although other aspects of risk-based
capital requirements are likely to work in the other direction. Further work on
evaluating the net effects is important for both supervisory and monetary
authorities.