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WP 2006/11 Zoltán Varsányi: Pillar I treatment of concentrations in the banking book - a multifactor approach

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Abstract

The present regulation of concentration risk does not take into consideration recent, sophisticated methods in credit risk quantification; the new Basle Capital Accord has left the regulatory treatment unchanged. Recently, substantial work has begun within the EU on this issue with the formation of the Working Group on Large Exposures within CEBS. The present paper is concerned with the models available under Basle 2 for credit risk quantification: it is searching for tools that can be applied in a new regime in general and that are capable of replicating the riskiness of credit portfolios with risk concentrations - an area that the original Basel model does not cover. The main idea of the paper is to disassemble nongranular portfolios into homogenous parts whose loss can then be directly simulated - taking into consideration the correlation between the parts - without the need to simulate single exposures. This makes the calculation of portfoliowide loss very fast.

JEL Classification: C15, G28.

Keywords: Basel regulation, multifactor model, NORTA, numerical integration.

WP2006_11