Do Banks hold enough capital to survive the next crisis? What about concentration and systemic risk in credit portfolios? How do we address these questions concretely to ensure solvency at times of crisis? How should these considerations specifically impact the pricing of a new loan?
This paper written by Thomas Ribarits (EIB) together with Axel Clement, Heikki Seppälä, Hua Bai and Ser-Huang Poon provides answers.
They take into account the complex specificities of a financial institution´s business profile by using an “economic capital framework” rather than a simplistic one-size-fits-all formula. Starting from a specific, sometimes complex, economic capital model, the paper is devoted to practical tractability: pricing decisions often need to be taken on a real time basis and do not allow for timely simulation runs which can be computationally expensive and unstable.
To manage the trade-off between complexity and practical tractability, a closed form approximation is introduced giving rise to a formula which provides accurate, consistent and quick answers to allow for e.g. informed pricing decisions.