Granularity Adjustment for Regulatory Capital Assessment
by Michael B. Gordya and Eva Lütkebohmertb
The credit value-at-risk model underpinning the internal
ratings-based approach of Basel II and III assumes that idiosyncratic
risk has been fully diversified in the portfolio, so that
economic capital depends only on systematic risk contributions.
We propose a simple granularity adjustment (GA) for
approximating the effect of undiversified idiosyncratic risk on
required capital. To mitigate operational burden in implementation,
we derive upper and lower bounds on the GA under
incomplete information on the portfolio. We assess the magnitude
and accuracy of the proposed GA on a set of bank
portfolios drawn from the German credit register.
JEL Codes: G32, G28, G17.
Full article (PDF, 40 pages 629 kb)
a Federal Reserve Board
b University of Freiburg