The University of Southampton
University of Southampton Institutional Repository

Optimal score cutoffs and pricing in regulatory capital in retail credit portfolios

Optimal score cutoffs and pricing in regulatory capital in retail credit portfolios
Optimal score cutoffs and pricing in regulatory capital in retail credit portfolios
This paper addresses the risk cutoff policies of a retail bank whose objectives are to maximize return on equity for shareholders and live within regulatory capital requirements, such as those of the Basel Capital Accord, to meet unexpected default losses. It investigates the changes that have to be made in the operating decision of which applicants for loans to accept and which to reject because of the changes in the financial regulations imposed on the bank. It is assumed that portfolios consist entirely of consumer credit accounts (mortgages, auto loans, revolving credit etc) for which acquisition risk scores are available to the lender and regulator. The solutions that we obtain not only yield an optimal cutoff score for default risk but also optimal pricing conditions for additional equity capital in the event that the existing level can not satisfy the regulatory requirements. The paper concludes with several numerical examples illustrating the effects of current and proposed Basel regulations. We believe that some important insights are derived from this formulation linking the financial variables such as the lending and borrowing rates, and the debt and equity structure of the lender and the operational decisions of which level of risk to set as the cutoff in the consumer credit portfolios.
regulatory capital, equity capital, basel accords, risk scoring, price of capital
CRR-09-01
University of Southampton
Oliver, R.M.
99bdb851-2532-4807-8704-caea709b4c01
Thomas, L.C.
a3ce3068-328b-4bce-889f-965b0b9d2362
Oliver, R.M.
99bdb851-2532-4807-8704-caea709b4c01
Thomas, L.C.
a3ce3068-328b-4bce-889f-965b0b9d2362

Oliver, R.M. and Thomas, L.C. (2009) Optimal score cutoffs and pricing in regulatory capital in retail credit portfolios (Discussion Papers in Centre for Risk Research, CRR-09-01) Southampton, UK. University of Southampton 21pp.

Record type: Monograph (Discussion Paper)

Abstract

This paper addresses the risk cutoff policies of a retail bank whose objectives are to maximize return on equity for shareholders and live within regulatory capital requirements, such as those of the Basel Capital Accord, to meet unexpected default losses. It investigates the changes that have to be made in the operating decision of which applicants for loans to accept and which to reject because of the changes in the financial regulations imposed on the bank. It is assumed that portfolios consist entirely of consumer credit accounts (mortgages, auto loans, revolving credit etc) for which acquisition risk scores are available to the lender and regulator. The solutions that we obtain not only yield an optimal cutoff score for default risk but also optimal pricing conditions for additional equity capital in the event that the existing level can not satisfy the regulatory requirements. The paper concludes with several numerical examples illustrating the effects of current and proposed Basel regulations. We believe that some important insights are derived from this formulation linking the financial variables such as the lending and borrowing rates, and the debt and equity structure of the lender and the operational decisions of which level of risk to set as the cutoff in the consumer credit portfolios.

Text
CORMSIS-09-01.pdf - Version of Record
Download (445kB)

More information

Published date: 2009
Keywords: regulatory capital, equity capital, basel accords, risk scoring, price of capital

Identifiers

Local EPrints ID: 71321
URI: http://eprints.soton.ac.uk/id/eprint/71321
PURE UUID: c0898119-b0a2-4919-bdef-beddc2cd7e0e

Catalogue record

Date deposited: 03 Feb 2010
Last modified: 13 Mar 2024 20:25

Export record

Contributors

Author: R.M. Oliver
Author: L.C. Thomas

Download statistics

Downloads from ePrints over the past year. Other digital versions may also be available to download e.g. from the publisher's website.

View more statistics

Atom RSS 1.0 RSS 2.0

Contact ePrints Soton: eprints@soton.ac.uk

ePrints Soton supports OAI 2.0 with a base URL of http://eprints.soton.ac.uk/cgi/oai2

This repository has been built using EPrints software, developed at the University of Southampton, but available to everyone to use.

We use cookies to ensure that we give you the best experience on our website. If you continue without changing your settings, we will assume that you are happy to receive cookies on the University of Southampton website.

×