N° 1 : How different is the regulatory capital from the economic capital: the case of business loans portfoliosheld by the major banking groups in France

This paper provides new evidence on this issue by using French Credit Register data and firms’ ratings histories of more than 160.000 French firms, including a large proportion of Small and Medium sized firms, to compute capital requirements in business loans portfolios of French banking groups. Using Credit Register information and ratings provided by the Banque de France rating system allows computing capital requirements by using a single common credit risk metrics and actual empirical rates of default at the bank’s exposure level. Using this information, capital ratios are computed for each banking group operating in the French business loans market. The paper addresses the issue of the ability of Basel 2 Internal Rating Based (IRB) formulas to hedge portfolio’s credit risk. Here, the analysis relies on an extension of the asymptotic single risk factor model (ASFR), which was used for the calibration of Basel II regulatory formulas. Therefore, a multifactor portfolio’s credit risk model is implemented to compute economic capital requirements taking account of potential credit risk concentration in business loans portfolios. The paper compares the required capital ratios provided with this model with the one required by the regulation. Our main findings are firstly that regulatory capital ratios do not underestimate credit risk: Basel II regulatory capital requirements are larger than the economic capital requirements. Secondly, the single risk factor regulatory model does not capture potential diversification effects in business loans portfolios. In the regulatory model, firms’ heterogeneity is only captured by their ratings. The introduction in the portfolio credit risk modeling of additional systematic risk factors - which are here size and sector – show that managing large portfolios composed of borrowers of different size or sector helps to produce diversification effects. Such situations lead in most cases to a decrease of the capital level required to cover future unexpected losses.