Abstract

The main result of this paper is the establishment of an analytic formula for the estimation capital requirements of an individual loan.

The derived formula, may be considered as a direct analogue to the Basel risk-weight functions for credit risk, first presented in Basel II framework, with the additional advantage of utilizing a lifetime horizon, thus being suitable for IFRS9/GAAP purposes. Essentially, it bridges the gap between Basel and IFRS9 frameworks as:

• The 1-year horizon incorporated in the Basel PD is extended up to maturity, following the IFRS9 rationale;
• The notion of unexpected losses, already supplied by Basel Framework, is added to the IFRS9 logic in an analytic fashion.

Going one step further, the generalization of the risk variables used in the formula, as Kumaraswamy identically distributed variables, allows for the benchmarking of the total loss of a credit portfolio, with the single knowledge of its current non-performing loans percentage.

This conclusion is successfully verified against EBA stress test results for the period 2018-2020.

This work is licensed under a Creative Commons Attribution 4.0 License.