Showing papers on "Credit risk published in 1999"

Evidence on the Determinants of Credit Terms Used in Interfirm Trade

Abstract: Trade credit is created whenever a supplier offers terms that allow the buyer to delay payment. In this paper we document the rich variation in interfirm credit terms and credit policies across industries. We examine empirically the firm's basic credit policy choices: whether to extend credit or to require cash payment; and, if credit is extended, whether to adopt simple net terms or terms with discounts for prompt payment. We also examine determinants of variations in two-part terms. Results are supportive primarily of theories that explain credit terms as contractual solutions to information problems concerning product quality and buyer creditworthiness. TRADE CREDIT HAS IMPORTANT ECONOMIC SIGNIFICANCE from both micro- and macroeconomic perspectives. During the 1990s vendor financing has accounted for an average $1.5 trillion of the book value of all assets of U.S. corporations and has represented approximately 2.5 times the combined value of all new public debt and primary equity issues during a given year. As a component of the money supply, trade credit, in the form of accounts payable, exceeds the primary money supply (MI) by a factor of 1.5 on average.1 Clearly, efforts to control economic growth through monetary policy can be confounded by aggregate decisions of businesses to increase or decrease reliance on trade-credit financing. Several recent empirical studies examine determinants of firm reliance on trade credit.2 These studies model supply and demand for trade credit using financial-statement data (accounts receivable and payable).3 However, many aspects of trade-credit practice are unexplored. Most notably, little is known about the types of credit terms (e.g., net 30, 2/10 net 30) and credit policies that are observed across firms and industries. The only comprehensive doc

Financial products having a demand-based, adjustable return, and trading exchange therefor

Abstract: This invention provides methods and systems for trading and investing in groups of demand-based adjustable-return contingent claims, and for establishing markets and exchanges for such claims. The advantages of the present invention, as applied to the derivative securities and similar financial markets, include increased liquidity, reduced credit risk, improved information aggregation, increased price transparency, reduced settlement or clearing costs, reduced hedging costs, reduced model risk, reduced event risk, increased liquidity incentives, improved self-consistency, reduced influence by market makers, and increased ability to generate and replicate arbitrary payout distributions, In addition to the trading of derivative securities, the present invention also facilitates the trading of other financial-related contingent claims; non-financial-related contingent claims such as energy, commodity, and weather derivatives; traditional insurance and reinsurance contracts; and contingent claims relating to events which have generally not been readily insurable or hedgeable such as corporate earnings announcements, future semiconductor demand, and changes in technology. A preferred embodiment of a method of the present invention includes the steps of (a) establishing a plurality of defined states and a plurality of predetermined termination criteria, wherein each of the defined states corresponds to at least one possible outcome of an event of economic significance; (b) accepting investments of value units by a plurality of traders in the defined states, and (c) allocating a payout to each investment upon the fulfillment of predetermined termination criteria.

Credit Risk Measurement: New Approaches to Value at Risk and Other Paradigms

Abstract: Why New Approaches to Credit Risk Measurement and Management? Traditional Approaches to Credit Risk Measurement. Loans as Options and the KMV Model. The VAR Approach: J.P. Morgana s CreditMetrics and Other Models. The Macro Simulation Approach: The McKinsey Model and Other Models. The Risk--Neutral Valuation Approach: KPMGa s Loan Analysis System (LAS) and Other Models. The Insurance Approach: Mortality Models and the CSFP Credit Risk Plus Model. A Summary and Comparison of New Internal Model Approaches. An Overview of Modern Portfolio Theory and Its Application to Loan Portfolios. Loan Portfolio Selection and Risk Measurement. Back--Testing and Stress-- Testing Credit Risk Models. RAROC Models. Off--Balance--Sheet Credit Risk. Credit Derivatives. Bibliography. Index.

Boom and Bust and Sovereign Ratings

Abstract: The 1990s have witnessed pronounced boom-bust cycles in emerging-markets lending, culminating in the Asian financial and currency crisis of 1997-98. By examining the links between sovereign credit ratings and dollar bond yield spreads over 1989-97, this paper aims at broad empirical content for judging whether the three leading rating agencies — Moody’s, Standard ' Poor’s and Fitch IBCA — can intensify or attenuate boom-bust cycles in emerging-market lending. First, an event study exploring the market response for 30 trading days before and after rating announcements finds a significant impact of imminent upgrades and implemented downgrades for a combination of ratings by the three leading agencies, despite strong anticipation of rating events. Second, a Granger causality test, by correcting for joint determinants of ratings and yield spreads, finds that changes in sovereign ratings are mutually interdependent with changes in bond yields. These findings are based on many more ...

Don't Put All Your Eggs in One Basket? Diversification and Specialization in Lending

Abstract: Should lenders diversify, as suggested by the financial intermediation literature, or specialize, as suggested by the corporate finance literature? I model a financial institution’s (“bank’s”) choice between these two strategies in a setting where bank failure is costly and loan monitoring adds value. All else equal, diversification across loan sectors helps most when loans have moderate exposure to sector downturns (“downside”) and the bank’s monitoring incentives are weak; when loans have low downside, diversification has little benefit, and when loans have sufficiently high downside, diversification may actually increase the bank’s chance of failure. Also, it is likely that the bank’s monitoring effectiveness is lower in new sectors; in this case, diversification lowers average returns on monitored loans, is less likely to improve monitoring incentives, and is more likely to increase the bank’s chance of failure. Diversified banks may sometimes need more equity capital than specialized banks, and increased competition can make diversification either more or less attractive. These results motivate actual institutions’ behavior and performance in a number of cases. Key implications for regulators are that an institution’s credit risk depends on its monitoring incentives as much as on its diversification, and that diversification per se is no guarantee of reduced risk of failure.

Financial Institutions Management: A Modern Perspective

Abstract: Part 1 Introduction: the financial services industry - depository institutions the financial services industry - insurance companies the financial service industry - securities firms and investment banks the financial services industry - mutual funds the financial services industry - finance companies why are financial intermediaries special risks of financial mediation. Part 2 Measuring risk: interest rate risk I interest rate risk II market risk credit risk - individual loan risk credit risk - loan portfolio and concentration risk foreign exchange risk sovereign risk liquidity risk. Part 3 Managing risk: liability and liquidity management deposit insurance and other liability guarantees capital adequacy product diversification geographic diversification - domestic geographic diversification - international futures and forwards options, caps, floors, and collars swaps, loan sales and other credit management techniques securitization.

Emerging Markets Instability : Do Sovereign Ratings Affect Country Risk and Stock Returns?

Abstract: Financial market instability has been the focus of attention of both academic and policy circles. Rating agencies have been under particular scrutiny lately as promoters of financial excesses, upgrading countries in good times and downgrading them in bad times. Using a panel of emerging economies, this paper examines whether sovereign ratings affect financial markets. The authors find that changes in sovereign ratings have an impact on country risk and stock returns. They also find that these changes are transmitted across countries, with neighbor-country effects being more significant. Rating upgrades (downgrades) tend to occur following market rallies (downturns). Countries with more vulnerable economies, as measured by low ratings, are more sensitive to changes in U.S. interest rates.

Credit risk and risk neutral default probabilities: information about rating migrations and defaults

Abstract: Default probabilities are important to the credit markets. Changes in default probabilities may forecast credit rating migrations to other rating levels or to default. Such rating changes can affect the firm’s cost of capital, credit spreads, bond returns, and the prices and hedge ratios of credit derivatives. While rating agencies such as Moodys and Standard & Poors compute historical default frequencies, option models can also be used to calculate forward looking or expected default frequencies. In this paper, we compute risk neutral probabilities or default (RNPD) using the diffusion models of Merton (1974) and Geske (1977). It is shown that the Geske model produces a term structure of RNPD’s, and the shape of this term structure may forecast impending credit events. Next, it is shown that these RNPD’s serve as bounds to estimates of actual default probabilities. Furthermore, the RNPD’s exhibit the same comparative statics as the estimates of actual default probabilities. Also, the risk neutral default probabilities may be more accurately estimated than actual default probabilities because they do not require an estimate of the firm’s drift. Given these similarities and advantages of RNPD’s, their estimates may possess significant information about credit events. To confirm this an event study of the relation between RNPD and rating migrations is conducted. We first show that these RNPD’s from both the Merton and Geske models do possess significant and very early information about credit rating migrations.While the sample of firms that actually default during this time period is small, changes in the shape of the term structure of default probabilities appears to detect impending migrations to default. This is shown to be consistent with an inverted term structure of default probabilities, where prior to an impending default, the short term default probability is higher than the forward default probability. Finally, since rating migrations to either lower ratings or to default can be detected months in advance these credit events may not be a surprise.

Lending Booms, Reserves, and the Sustainability of Short-Term Debt: Inferences from the Pricing of Syndicated Bank Loans

Abstract: Academics pay little attention to international bank lending, focusing instead on rapidly growing market segments such as the international bond market and derivative credit instruments. The authors argue for paying more attention to international bank lending. Why? Three reasons. First, the syndicated bank loan is one of the workhorses of international capital markets. Second, international bank lending is especially important for private-sector borrowers, whose participation in international capital markets will grow as capital markets are liberalized and state enterprises privatized. Sovereigns and other governmental borrowers rely more on the bond market, while private borrowers are disproportionately important to the market in international bank loans. Private-sector borrowers establish long-term relationships with banks to resolve information problems. The authors find that international banks provide more credit to smaller borrowers (about whom information is least complete) than bond markets do. Bank finance dominates that segment of international financial markets with the greatest information asymmetry. Third, spreads on syndicated bank loans show much less variation than spreads on international bonds. Are bank lenders properly pricing country and credit risk? Does spread compression on syndicated bank loans suggest excessive moral hazard in international bank lending? The authors warn against over-dependence on high levels of domestic debt. While growth in domestic debt reflects improved inter-mediation between savers and investors, rapid increases to high levels are viewed as unsustainable and raise the cost of international borrowing. They find evidence of growing bullishness among bank lenders to East Asia in the first half of the 1990s, which could reflect moral hazard, but the jury is still out on that issue. High external short-term debt can coexist with rapid growth for extended periods but is likely to unravel if perceptions of sustainability shift.

Credit risks and European government bond markets: a panel data econometric analysis

Abstract: A fixed effects panel data estimation of the determinants of European government default risk is undertaken. Credit risk of sovereign debt is assessed by comparing yields on benchmark government bonds with high-quality private risk represented by interest rate swap yields. Using a new data-set from the European Commission (DG2's AMECO database), we find government default risk to depend positively on changes in the debt to GDP ratio and the variability of inflation and negatively on lagged inflation and changes in taxable capacity. Finally, there is evidence for persistence of government bond yield spreads reflecting differences in cross-country government default risk.

Determinants of household access to and participation in formal and informal credit markets in malawi

Abstract: The paper uses the concept of credit limit to analyze the determinants of household access to and participation in informal and formal credit markets in Malawi. Households are found to be credit constrained, on average, both in the formal and informal sectors; they borrow, on average, less than half of any increase in their credit lines. Furthermore, they are not discouraged in their participation and borrowing decisions by further increases in the formal interest rate and/or the transaction costs associated with getting formal credit. This suggests that getting access to credit is much more important than its cost for these households. Hence, credit policies should focus on making access easier rather than providing credit with subsidized interest rates. The composition of household assets is found to be much more important as a determinant of household access to formal credit than the total value of household assets or landholding size. In particular, a higher share of land and livestock in the total value of household assets is negatively correlated with access to formal credit. However, land remains a significant determinant of access to informal credit. Therefore, poor households whose assets consist mostly of land and livestock but who want to diversify into nonfarm income generation activities may be constrained by lack of capital. As informal loans are usually too small to help poor households start a viable nonfarm business, these households may be forced to rely on farming as the sole source of income, despite its unreliability because of the frequency of drought in Malawi. Finally, formal and informal credit are found to be imperfect substitutes. In particular, formal credit, whenever available, reduces but does not completely eliminate informal borrowing. This suggests that the two forms of credit fulfill different functions in the household's intertemporal transfer of resources.

The Siskel and Ebert of Financial Markets: Two Thumbs Down for the Credit Rating Agencies

Abstract: This paper critiques the role of credit ratings and credit rating agencies in providing information about bonds. The dominant "reputational capital" view of credit rating agencies is that the agencies have survived and prospered since the early 1900s based on their ability to accumulate and retain reputational capital (i.e., good reputations) by providing valuable information about the bonds they rate. The paper argues that this view fails to explain, and is inconsistent with, certain types of market behavior including: the estimation of credit spreads, the number of credit ratings-driven transactions, and the explosion in use of credit derivatives. In place of the reputational capital view, the paper offers a "regulatory license" view of rating agencies as generating value, not by providing valuable information, but by enabling issuers and investors to satisfy certain regulatory requirements. The paper concludes that regulators should eliminate regulatory dependence on credit ratings by substituting a regime based on market-determined bond credit spreads (i.e., the difference between the yield on a bond and the yield on a risk-free bond of comparable maturity). Such credit spreads reflect all available information, including credit ratings, and therefore are more accurate and reliable than credit ratings.

An Introduction to Value-at-Risk

Abstract: Foreword. Preface. Preface to the First Edition. About the Author. 1. Introduction to Risk. 2. Volatility and Correlation. 3. Value-At-Risk. 4. Value-At-Risk and Fixed Interest Instruments. 5. Options: Risk and Value-At-Risk. 6. Monte Carlo Simulation and Value-At-Risk. 7. Regulatory Issues and Stress-Testing. 8. Credit Risk and Credit Value-At-Risk. Case Study and Exercises. Appendix: Taylor's Expansion. Abbreviations. Selected Bibliography. Index.

Deposit insurance and risk-taking behavior in the credit union industry

Abstract: This paper examines the relationship between deposit insurance and risk-taking behavior within the credit union industry. Time series tests employing industry average financial ratios for federal and state credit unions did not support the increased risk-taking hypothesis. Although federal credit union capital declined immediately following the adoption of deposit insurance, this was most likely the result of reduced capital requirements, not deposit insurance. Liquidity and loan delinquency ratios had a negative time trend coefficient, implying a decline in risk-taking behavior during the post-insurance period. Cross-sectional test results employing Iowa state-chartered credit union data indicated that insured credit unions were better capitalized and more liquid than their uninsured counterparts. Overall there was no evidence that the adoption of deposit insurance increased the risk-taking behavior of credit unions.

An analysis of offer functions of banks and credit unions in Guatemala

Abstract: Economists have sought to identify institutions which might fill the gap in household access to credit arising from rationing by formal lenders. Credit unions have been identified as institutions which might use informational and monitoring advantages to fill that gap. Using information on household perceptions of their access to credit, this article analyses the impact of certain credit unions on the access to credit of households in Guatemala. Regression results indicate that credit unions serve markets unserved by formal lenders and that information on household perceptions of their access to credit is important in making inferences about lender lending activities.

Credit risk and financial instability

Abstract: Recent advances in modelling credit risk bring much greater discipline to the pricing of credit risk and should promote diversification by penalizing concentrations of credit risk with greater allocations of economic capital. Although these models perform well with regard to high-frequency hazards, they are ill equipped to deal with the low-frequency, high-severity events that are likely to be the most serious threat to financial stability. Cognitive biases in estimating the probability of such losses may lead to disaster myopia. In periods of benign financial conditions, disaster myopia is likely to lead to decisions regarding allocations of economic capital, the pricing of credit risk, and the range of borrowers who are deemed creditworthy, that make the financial system increasingly vulnerable to crisis. Alternative policy measures to counter disaster myopia are considered.

Internal Credit Risk Models: Capital Allocation and Performance Measurement

Abstract: Internal Credit Risk Models Capital Allocation and Performance Measurement -------------------------------------------------------------------------------- CONTENTS On Basle, Regulation and Market Responses Past and Present Origins of the Regulatory Capital Framework Some Historical Perspectives Historical Rational for the Capital Accord Credit Risk, Regulatory Capital and the Basle Accord Evolutionary Nature of Capital Regulation Market Response: Clamour for Internal Credit Models Game Theory: Regulatory Capital Arbitrage Securitisation of Assets Concerns Raised by Securitisation Role of Credit Derivatives Summary of Federal Deposit Insurance Corporation Improvement Act 1991 Regulatory Capital Rules Overview of Approach Essential Components of the Internal Credit Risk Model Outline of Model Components Preview of Following Chapters Modelling Credit Risk Elements of Credit Risk Default Risk Measuring Default Probability - Empirical Method Measuring Default Probability - The Options Theory Approach Theoretical EDFs and Agency Ratings Credit Risk Models Value of Risk Debt States of the Default Process and Credit Migration Merton's Options Theory Approach to Risky Debt Default Probability, the Default Point and the Distance to Default Mathematical Preliminary The Multi-State Default Process and the Probability Measure Loan Portfolios and Expected Loss Expected Loss Adjusted Exposure: Outstandings and Commitments Covenants Adjusted Exposure Usage Given Default Loss Given Default and the Risky Part of V1 Mathematical Derivation of Expected Loss Parameterising Credit Risk Models Unexpected Loss Causes of Unanticipated Risk Unexpected Loss Economic Capital and Unexpected Loss Derivation of Unexpected Loss (UL) Portfolio Effects: Risk Contribution and Unexpected Losses Comparing Expected Loss and Unexpected Loss The Analysis Horizon and Time to Maturity Portfolio Expected Loss Portfolio Unexpected Loss Risk Contribution Undiversifiable Risk Risk Contribution and Correlation of Default Variation in Asset Value due to Time Effects Derivation of Portfolio UL Derivation of Portfolio RCk Correlation of Default and Credit Quality Correlation of Credit Quality Correlation of Default Default Correlation Matrix and Some Important Observations Industry Index and Asset Correlation Estimating Asset Correlation Obligor-Specific Risk Further Generalisation to the Multifactor Case Some Comments and Suggestions Correlation of Default First-Passage Time Model of Default Correlation Industry Default Correlation Matrix Correlation of Joint Credit Quality Movement Loss Distribution for Credit Default Risk Choosing the Proper Loss Distribution The Beta Distribution Economic Capital and Probability of Loss Extreme Events: Fitting the Tail Monte Carlo Simulation of Loss Distribution Simulating the Loss Distribution Some Observations From the Examples Why EVT and not just Simulation Mathematics of Loss Simulation Simulating Default and the Default Point Extreme Value Theory Fundamental Regimes for Losses Extreme Value Theory - Some Basics Generalised Pareto Distribution Convergence Criteria Thresholds Revisited The Mean Excess Function History Repeating by Alexander McNeil Risk-Adjusted Performance Measurement Risk-Adjusted Performance Measurement Raroc Defined Dissecting the Raroc Equation Approaches to Measurement: Top-Down or Bottom-Up Revised RAPM Implementing the Internal Model Across the Enterprise Sample Portfolio Negative Raroc Parameterising and Calibrating the Internal Model Interpreting the Results of Raroc Enterprise-Wide Risk Management and RAPM Sample Credit Portfolio On to the Next Steps Credit Concentration and Required Spread The Credit Paradox Causes of Concentration Risk Credit Concentration and Required Spread The Loan Pricing Calculator Mathematics of the Loan Pricing Calculator Epilogue: The Next Steps Internal Credit Risk Ratings Data Quality and Opaqueness Techniques for Assessing Extreme Loss Distributions Risk-Adjusted Performance Measurement and Risk-Adjusted Pricing Multi-State Default Process, Marking-to-Market and Multi-Year Analysis Horizons Differences Between Vendor Models Integration of Market Risk and Credit Risk The Multi-State Default Process Matching Transition Matrices to Historical Data Appendix Raroc Remodelled Tom Wilson Many Happy Returns Sanjeev Punjabi Reconcilable Differences H. Ugur Koyluoglu and Andrew Hickman Refining Ratings Ross Miller A Credit Risk Toolbox Angelo Arvanitis, Christopher Browne, Jon Gregory, and Richard Martin

Counterparty Risk and the Pricing of Defaultable Securities

Abstract: Motivated by recent financial crises in East Asia and the U.S. where the downfall of a small number of firms had an economy-wide impact, this paper generalizes existing reduced-form models to include default intensities dependent on the default of a counterparty. In this model, firms have correlated defaults due not only to an exposure to common risk factors, but also to firm-specific risks that are termed ``counterparty risks.'' Numerical examples illustrate the effect of counterparty risk on the pricing of defaultable bonds and credit derivatives such as default swaps.

An Integrated Market and Credit Risk Portfolio Model

Abstract: We present a multi-step model to measure portfolio credit risk that integrates exposure simulation and portfolio credit risk techniques. Thus, it overcomes the major limitation currently shared by portfolio models with derivatives. Specifically, the model is an improvement over current portfolio credit risk models in three main aspects. First, it defines explicitly the joint evolution of market factors and credit drivers over time. Second, it models directly stochastic exposures through simulation, as in counterparty credit exposure models. Finally, it extends the Merton model of default to multiple steps. The model is computationally efficient because it combines a Mark-to-Future framework of counterparty exposures and a conditional default probability framework.

Valuation of European Options Subject to Financial Distress and Interest Rate risk

Abstract: Like the previous article, Klein and Inglis focus on credit risk. But in this case, it is the credit worthiness of the writer of a derivative instrument whose solvency is at issue. The risk of default on a vulnerable contract depends on the (correlated) changes in the value of the underlying for the derivative instrument, the value of the assets of the firm that writes the contract, and the risk-free interest rate. This article derives closed-form valuation equations for vulnerable European calls and puts and presents a number of numerical examples to illustrate the impact of the different model parameters on option value relative to Black-Scholes.

A Model of Sovereign Borrowing and Sovereign Yield Spreads

Abstract: In a continuous-time setting, we model the problem of sovereign borrowing. In our model, borrowing is used to generate exports. The sovereign borrower in our model is subject to two types of potential retaliatory actions from the lender in the event of default. First, the lender can capture a part of production in the event of default. Second, the lender can impose trade sanctions in the spirit of Bulow and Rogoff (1989a). Such sanctions reduce the flow rates of future output of the domestic production in this model. The borrower takes these potential actions into account in the choice of optimal voluntary default and the optimal debt level. The sovereign loan contract differs from an otherwise identical corporate debt contract in our model by the fact that the latter is protected by the bankruptcy code which gives a better access to the collateral of the borrower. This difference alone is sufficient to cause the optimal default strategies to differ significantly for sovereign contracts as compared to corporate debt. The sovereign debt is renegociated more often and yield spreads between sovereign and corporate debt can be as high as 25 basis points. If after borrowing, the fortunes of the borrowing country were to decline, there will be a debt overhang. We show that this problem is mitigated by renegotiated reductions in the debt service payments.

Do markets discipline banks and bank holding companies? evidence from debt pricing

Abstract: Whether the federal safety net under banks is viewed by the market as being extended beyond de-jure deposits to other bank debt and even the debt of bank holding companies (BHCs) has important public policy implications for the ability of market forces to monitor and discipline banks and, in particular, for current proposals to require commercial banks or bank holding companies to issue a minimum amount of subordinated debt. Securities perceived with certainty to be covered by the safety net would not be priced by the market according to the riskiness of the issuer. The weaker the perception, the greater is the relationship between the market yields on the security and the risk characteristics of the issuer and the greater is the ability of creditors and the market to discipline banks. This paper extends the empirical research of previous investigators in two directions. One, it uses observations for U.S. banks for the post-FDICIA period, in which the breadth of the safety net may be more restricted than before. Two, it is the first to examine the risk-return relationship of bonds issued directly by banks, not only by BHCs as did previous studies. Our paper provides evidence that both U.S. bank and BHC bonds are priced by the secondary market in relation to their underlying credit risk, particularly for less-capitalized issuers. Moreover, risk appears to be priced similarly for both types of bonds. This suggests that proposals requiring banks or BHCs to issue subordinated debt may enhance market monitoring and discipline and be useful in supplementing regulatory discipline.

A generalized framework for credit risk portfolio models

Abstract: Sophisticated new credit risk portfolio modeling techniques have been developed recently, holding the potential for substantial reform of credit risk management techniques and regulatory capital guidelines. This paper examines three such credit risk portfolio models, placing them within a single general framework and demonstrating that they are little different in either theory or results, provided that input parameters are harmonized. This result, that a strong consensus has emerged in the approach to modeling default risk, has significant implications for the acceptance of these new techniques amongst both end-users and regulators.

Predicting Default Rates: A Forecasting Model for Moody's Issuer-Based Default Rates

Abstract: This study introduces a new model for predicting future default rates. The model leverages off of the statistical relationships underlying Moody's trailing 12-month issuer-based default rate - a widely monitored indicator of corporate credit quality - to offer a superior alternative to previous forecasting techniques. The model incorporates the effect on default rates of changes in the universe of issuers, both in terms of their credit ratings and the time since they first came to market (the "aging effect"), and of macroeconomic conditions as measured by the industrial production index and interest rate variables.

Financial characteristics of interest-free banks and conventional banks

Abstract: Many countries all over the world currently experience what became known as "Dual Banking" where interest-fi-ee Islamic banks operate side by side with conventional banks. Islamic banks conduct normal business as any conventional bank but do not pay or receive interest. They operate on profit/loss sharing principle. By this, is meant both the supplier of the flinds and the borrower share the risks; both prosper when returns are favorable and suffer together when returns are poor. The literature on Islamic banking and finance though recent is growing fast. Western scholars have begun to show an interest and make substantial contributions. The interdisciplinary nature of the literature offers a challenge. However, there are still numerous questions to be answered, many problems to be solved and a number of challenges to be faced. In particular, empirical work is needed to assess the differences in financial characteristics of interest-free and conventional banks. Also, nothing much has been written about the loan market in a dual banking system. Moreover, very little is known about the attitudes of clients towards Islamic vis-a-vis traditional banks. Furthermore, research on the performance of Islamic banks in individual countries has not received much attention. This thesis is an interdisciplinary study which attempts to make a (very) modest contribution towards filling the gap in the literature. In particular, this study tests for structural differences between the financial characteristics of Islamic and traditional banks. This testing is done through the use of discriminant analysis apphed to a sample of 48 Middle Eastern banks, 12 of which are interest-fi-ee banks. The analysis covers 20 financial ratios which evaluate liquidity, leverage, performance, credit risk, probability and efficiency. This study also tries to model the decision, of a chent facing a dual banking system, to deal with a traditional or an Islamic bank. This is done using logit and probit regression analysis. A simuhaneous equations model is developed and tested using time series data for 18 conventional banks and 12 Islamic banks to examine the performance of the commercial loan market within a dual-banking system. Moreover, this thesis tries to test if the transactions of Islamic banks are really free of all traces of "usury interest". A case study of the Kuwait Finance House is conducted. This involves in-depth analysis of the activities, products and financial statements of this company. The clients' perceptions of Islamic banking are also examined. This is done through the application of factor analysis to survey resuHs collected by the researcher

An Empirical Analysis of Personal Bankruptcy and Delinquency

Abstract: This paper uses a unique new panel data set of credit card accounts to analyze credit card delinquency and more generally personal bankruptcy and the stability of credit risk models. We estimate duration models for default and assess the relative importance of different variables in predicting default. We investigate how the propensity to default has changed over time, disentangling the two leading explanations for the recent increase in default rates – a deterioration in the risk-composition of borrowers versus a reduction in the social stigma of default. Even after controlling for risk-composition and other economic fundamentals, the propensity to default significantly increased between 1995 and 1997. By contrast, increases in credit limits and other changes in risk-composition explain only a small part of the change in default rates. Standard default models appear to have missed an important time-varying default factor, consistent with the stigma effect.

Community Reinvestment and Credit Risk: Evidence from an Affordable‐Home‐Loan Program

Abstract: This study examines the performance of home purchase loans originated by a major depository institution in Philadelphia under a flexible lending program between 1988 and 1994. We examine long-term delinquency in relation to neighborhood housing market conditions, borrower credit-history scores and other factors. We find that likelihood of delinquency declines with increasing neighborhood housing market activity. Also, likelihood of delinquency is greater for borrowers with low credit-history scores and those with high ratios of housing expense to income, and when the property is unusually expensive for the neighborhood where it is located.

Default Risk and the Effective Duration of Bonds

Abstract: Estimates of how much credit risk shortens the effective duration of corporate bonds based on observable data and easily estimated bond pricing parameters. Basis risk is the risk attributable to uncertain movements in the spread between yields associated with a particular financial instrument or class of instruments, and a reference interest rate over time. There are seven types of basis risk: Yields on - Long-term versus short-term financial instruments. - Domestic currency versus foreign currencies. - Liquid versus illiquid investments. - Bonds with higher or lower sensitivity to changes in interest rate volatility. - Taxable versus tax-free instruments. - Spot versus futures contracts. - Default -f ree versus non - default - free securities. Basis risk makes it difficult for the fixed-income portfolio manager to measure the portfolio's exposure to interest rate risk, heightens the anxiety of traders and arbitrageurs who are hedging their investments, and compounds the financial institution's problem of matching assets and liabilities. Much attention has been paid to the first type of basis risk. In recent years, attention has turned toward understanding the relation between credit risk and duration. Babbel, Merrill, and Panning focus on that, emphasizing the importance of taking credit risk into account when computing measures of duration. The consensus of all work in this area is that credit risk shortens the effective duration of corporate bonds. The authors estimate how much durations shorten because of credit risk, basing their estimates on observable data and easily estimated bond pricing parameters. An earlier version of this paper - a product of the Financial Sector Development Department - was presented at the Second Biennial Conference on the Financial Dynamics of the Insurance Industry, New York University.

Evaluating Credit Risk Models

Abstract: Over the past decade, commercial banks have devoted many resources to developing internal models to better quantify their financial risks and assign economic capital. These efforts have been recognized and encouraged by bank regulators. Recently, banks have extended these efforts into the field of credit risk modeling. However, an important question for both banks and their regulators is evaluating the accuracy of a model's forecasts of credit losses, especially given the small number of available forecasts due to their typically long planning horizons. Using a panel data approach, we propose evaluation methods for credit risk models based on cross-sectional simulation. Specifically, models are evaluated not only on their forecasts over time, but also on their forecasts at a given point in time for simulated credit portfolios. Once the forecasts corresponding to these portfolios are generated, they can be evaluated using various statistical methods.