Abstract:
Vasicek’s asymptotic single risk factor (ASRF) model is employed by the Basel Committee
on Banking Supervision (BCBS) in its internal ratings-based (IRB) approach for estimating credit losses
and regulatory credit risk capital. This methodology requires estimates of asset correlations; these are
prescribed by the BCBS. Practitioners are interested to know market-implied asset correlations since
these influence economic capital and lending behavior. These may be backed out from ASRF loan
loss distributions using ex post loan losses. Prescribed asset correlations have been neither updated
nor recalibrated since their introduction in 2008 with the implementation of the Basel II accord. The
market milieu has undergone significant alterations and adaptations since then; it is unlikely that
these remain relevant. Loan loss data from a developed (US) and developing (South Africa) economy
spanning at least two business cycles for each region were used to explore the relevance of the BCBS
calibration. Results obtained from three alternative methodologies are compared with prescribed
BCBS values, and the latter were found to be countercyclical to empirical loan loss experience,
resulting in less punitive credit risk capital requirements than required in market crises and more
punitive requirements than required in calm conditions.
