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Giulia Fusi

20 December 2022
WORKING PAPER SERIES - No. 2760
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Abstract
When the Covid-19 crisis struck, banks using internal-rating based (IRB) models quickly recognized the increase in risk and reduced lending more than banks using a standardized approach. This effect is not driven by borrowers’ quality or by banks in countries with credit booms before the pandemic. The higher risk sensitivity of IRB models does not always result in lower credit provision when risk intensifies. Certain features of the IRB models – the use of a downturn Loss Given Default parameter –can increase banks’ resilience and preserve their intermediation capacity also during downturns. Affected borrowers were not able to fully insulate and decreased corporate investments.
JEL Code
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation
20 December 2022
RESEARCH BULLETIN - No. 102
Details
Abstract
When the coronavirus (COVID-19) pandemic struck, it was vital for many firms to retain access to funding from banks. In order to calculate their capital requirements, banks measure borrowers’ credit risk using either “their own”, internal ratings-based (IRB) models, or a standardised approach. This analysis examines whether model-based bank regulation constrained lending during the COVID-19 crisis. Results show that banks using their own models extended less credit than banks using a standardised approach. This outcome was not dependent on borrowers’ characteristics, or the credit booms seen in some countries, but is connected to the IRB models that some banks use. Certain features of the models such as the “downturn loss-given default” parameter, which reflects how much money a bank can expect to lose when borrowers default on loans during downturns, are helpful to bolster banks’ resilience and preserve their intermediation capacity during times of economic decline.
JEL Code
G21 : Financial Economics→Financial Institutions and Services→Banks, Depository Institutions, Micro Finance Institutions, Mortgages
G28 : Financial Economics→Financial Institutions and Services→Government Policy and Regulation