basel ii capital requirements for structured credit products.pdf

Basel II capital requirements for structured credit products and economic capital: a comparative analysis∗ † ‡ Luca Giaccherini , Giovanni Pepe first draft August 2007, this version Febraury 2008 Abstract The huge development experienced by structured credit products has oc- curred under a banks’ capital adequacy regime inconsistent with the inherent complexity of these securities. The new prudential framework (Basel II) con- tains a specific section devoted to tranched products, which puts much store on public ratings. In this paper we try to evaluate the reliability of Basel II treatment for securitization exposures comparing the forthcoming charges for structured products with an estimate of their risk, a topic that deserves additional attention after the recent market turmoil. The results obtained cast some doubts about the actual degree of conservatism of the choice to map from ratings to prudential charges. Keywords: Basel II, CDO, economic capital, regulatory capital, Value at Risk. Contents 1 Introduction 3 2 Collateralized debt obligation (CDO) 4 2.1 Single-Tranche CDOs . . . . . . . . . . . . . . . . . . . . . . . . 5 3 Regulatory treatment 7 3.1 The rational behind the RBA and SFA approaches . . . . . . . . . 8 4 A model for the conditional loss distribution 10 4.1 The pricing model . . . . . . . . . . . . . . . . .