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APRA 20% LGD floor Cont… March 7, 2007

Posted by riskopedia in Basel II, LGD, Retail Risk.
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There is another article I have found
http://www.apra.gov.au/RePEc/RePEcDocs/Archive/discussion_papers/dp0014.pdf

Again, similar para. on P.8 “Loss-given-default Loss-given-default (LGD) in the proposed MER model is based on the long-run average LGD of 20 per cent reported by LMIs, across all LVR buckets, from 1980 to 2000. Consistent with economic intuition, the proposed model allows LGD to vary with LVR. This increases the model’s sensitivity to risk compared with the current model, which has a flat LGD across all LVR buckets.”

Regardless of what results we have in MER model, I have couple of comments:

– From a general logical pt. (also proven in APRA stress testing results), a bank would expect to get a Higher LGD% for those High LVR Young accounts during downturn. But if a loan got below 70% – 80% LVR (just assume no LMI), even if the property price dropped by 20% (during a downturn). The “LGD” is very unlikely to be 20%, when it pretty much means the price of the property would of dropped by another 10-20%. (i.e. the asset value cannot cover the remaining loan)

– LMI industry normally deals with High risk loan, e.g. LVR > 80% (at least) or high risk customer (from bank’s perspective). As for retail banks, large proportion of the loan is normally <= 80%. Hence, would not be surprised if retail bank has a low LGD figures (again, forget about the whole beign economic environment). So, I do question the use of LMI results on 20% LGD.

– Basel Accord indicated that a bank needs to segment LGD if can do. So, if one bank decided to have multiple LGDs values (whether based on LVRs, Age of Account etc.), I do not believe to set a 20% floor is appropriate when it kinda contradict what Basel is trying to achieve. Else, why we would have segmented LGD in the first place?

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