STRESS TESTING FOR DEFAULT PROBABILITIES IN BANKING INDUSTRY; AN APPLICATION OF CREDIT PORTFOLIO APPROACH

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ABDOLSHAH FATEMEH; MOSHIRI SAEED

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Journal: ECONOMIC RESEARCH REVIEW Year:2017 | Volume:17 | Issue:66 Page(s): 23-54

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Title

STRESS TESTING FOR DEFAULT PROBABILITIES IN BANKING INDUSTRY; AN APPLICATION OF CREDIT PORTFOLIO APPROACH

Author(s)

ABDOLSHAH FATEMEH | MOSHIRI SAEED | Issue Writer Certificate

Keywords

CREDIT RISKQ2

STRESS TESTQ1

WILSON MODELQ1

SIMULATIONQ2

BANKING INDUSTRYQ2

Abstract

Because of prevalence of non-performing loans in Iranian banking sector, it is important to estimate the default probability of borrowers in order to effectively manage CREDIT RISK. This paper conducts STRESS TESTing for default probabilities in BANKING INDUSTRY of Iran. We apply the credit portfolio approach model developed by Wilson (1997) and analyze the impacts of various macroeconomic shocks on default rates of banks. In the constructed model, we first estimate the effects of macroeconomics variables on default rate. Then the dynamic relationship between selected macroeconomics variables is estimated by a VAR model. Residuals obtained in the two previous steps were used to construct the covariance matrix for system of equations. Finally, using the Monte-Carlo method, a path of default probabilities is simulated in a one-year horizon under different scenarios. We compare default rates under different stress scenarios with baseline scenario to identify the effects of different shocks. The results of SIMULATION show that unemployment rate shock has been the most harmful factor for default probabilities, followed by exchange rates shock. A shock to GDP growth also affects default rates significantly. Inflation shock generates the least important effect on default rates, consistent with the insignificant coefficient of inflation rate in the estimated default probability equation. A simultaneous shock to all macroeconomic variables has higher impact on the default rates in lower tails than upper tails. The results also show the effects of shocks decrease with the passage of time.

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APA: Copy

ABDOLSHAH, FATEMEH, & MOSHIRI, SAEED. (2017). STRESS TESTING FOR DEFAULT PROBABILITIES IN BANKING INDUSTRY; AN APPLICATION OF CREDIT PORTFOLIO APPROACH. ECONOMIC RESEARCH REVIEW, 17(66 ), 23-54. SID. https://sid.ir/paper/67054/en

Vancouver: Copy

ABDOLSHAH FATEMEH, MOSHIRI SAEED. STRESS TESTING FOR DEFAULT PROBABILITIES IN BANKING INDUSTRY; AN APPLICATION OF CREDIT PORTFOLIO APPROACH. ECONOMIC RESEARCH REVIEW[Internet]. 2017;17(66 ):23-54. Available from: https://sid.ir/paper/67054/en

IEEE: Copy

FATEMEH ABDOLSHAH, and SAEED MOSHIRI, “STRESS TESTING FOR DEFAULT PROBABILITIES IN BANKING INDUSTRY; AN APPLICATION OF CREDIT PORTFOLIO APPROACH,” ECONOMIC RESEARCH REVIEW, vol. 17, no. 66 , pp. 23–54, 2017, [Online]. Available: https://sid.ir/paper/67054/en

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