Provide a model for calculating the economic capital of bank loan portfolio and compare it with regulatory capital

The purpose of this article is to provide a model for calculating the economic capital of a bank loan portfolio and compare the obtained results with regulatory capital based on Basel II Models. The widely used asset value approach is used to model the default correlation. The method of estimating the parameters is based on the Method of moments and the method of maximum likelihood. Finally, the economic capital is calculated based on the distribution of losses obtained from the Monte Carlo simulation method. According to research hypothesis, calculated economic capital is compared with calculated regulatory capital based on Basel II Models. Regarding obtained results regulatory capital is more than economic capital. Considering the difference between economic capital and regulatory capital in the selected portfolio, it is not sufficient to rely on regulatory capital to assess banks’ risk. In order to have an accurate assessment of banks’ risk, economic capital must be calculated with proper modeling.

Keywords:

credit risk , Probability of Default , economic capital , Value at Credit Risk