assessment of default probability in conditions of cyclicality totmyanina ksenia moscow, 2014
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Assessment of default probability in conditions of cyclicality
Totmyanina Ksenia
Moscow, 2014
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Actuality• Corporate sector represents a significant part of banking
business worldwide.
• Loans to corporates are a significant part of Russian banking portfolio: to the end of 2013 loans to corporates reached 56% of total credit portfolio and 39% of total assets of Russian banks.
• Number of researches devoted to corporate credit risk estimation is strongly limited, especially for emerging market economies.
• Level of non-performing loans in corporate portfolio is increasing - this fact can lead to instability of Russian financial and banking system
• Construction companies are the most widespread among Russian borrowers and at the same time very exposed to systematic risksObject of research – Russian contracting companiesItem of research – Assessment of default probability
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Purpose of researchThe purpose of our research is to develop an empirical model for estimation default probability of potential corporate clients of Russian banks.
The key steps to achieve this purpose are:
• research the different approaches to default definitions• represent the classification of existing models to default modeling,
review the advantages and disadvantages of these models• analyze the nature and sources of the procyclicality effect, represent
the review of available instruments to mitigation of the procyclicality effect
• collect the sample of financial indicators for defaulted and non-defaulted companies and macro factors for the specified period
• execute a statistical analysis to determine the sensetive financial indicators and macro factors
• execute a multivariable analysis to build sets of logit models• analyze the quality and predictive power of final model and represent
the economic interpretation of the observed relationship
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Default definitions
There are a lot of approaches:
• Default as non-fulfillment the conditions of the
loan agreement due to inability or unwillingness
of the borrower
• Default as the bankruptcy
• Default based on BIS criteria:
overdue more than 90 days and / or
bank considers that the debtor is unable to repay the
loan
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Review of default models
1.2 Market-based models 1.1 Fundamental-based models
1.1.3 Rating-based models
Cohort approach
1.1. 2 Macroeconomics models
Binary choice models
Univariate discrimination
Multiple discrimination
Reduced forms
Structural models 1.1.1 Models based on financial statements
Scoring models
Exogenous factors
Endogenous factors Duration approach
1.3 Advanced models Linear discrimination models
Neuron networks
Fuzzy sets models
Probability of default models
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Procyclicality issueProcyclical effect - increased business cycle fluctuations
Sources can be different:
1) Prudential control: for example, capital adequacy requirements increase during periods of recession and reduce during the period of growth
2 ) The behavior of economic agents: for example, lending activity increase in periods of growth and decrease in periods of recession
3) Expectations of economic agents: for example, the risk is underestimated in the periods of growth, and overestimated during recessions
4) The corporate governance system: for example, the KPI systems and bonuses for managers
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Procyclicality mitigation instruments
via inputs data via outputs data
EAD conversion
TTC LGD Other parameters
Time horizon
TTC PD
Quantile
Macro factors
Scalar factor
Conter-cyclicality index
Capital buffers
Dynamic provisions
Stress-testing
Mitigations of procyclicality
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Financial parameters that can be statistically significant
Group of financial factors potentially affecting the level of credit risk: •Size•Profitability•Turnover•Financial stability
We formed a long list of financial indicators from each class above - finally total list consists of 31 indicators
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Sample for modeling
• All defaulted companies in constructing industries during 2005-2013 – 159 companies
• Default = bankruptcy • For each defaulted companies we had 3 analogical (same size
and industry) non-defaulted companies – 477 non-defaulted companies
2005 2006 2007 2008 2009 2010 2011 2012 20130
5
10
15
20
25
30
35
40
Defaults dynamics
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Univariate analysis: selection of the risk dominant financial indicators
Instruments:1)Analysis and normalization of data (Chebyshev’s
inequality)2)Statistical tests to identify the most descriptive
variables (Student's test, Welch tests, ANOVA test)
More risk-dominant factors:Balance value Return on sales Working capital Share of stocks in current assets Return on assets Profitability of expensesCoefficient of autonomy
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Univariate analysis: selection of the risk sensitive macro indicators
Instruments:1)Analysis and normalization of data (Chebyshev’s
inequality)2)Regression models between macro factors and
average default rate (based on S&P data)
More sensitive macro factors:Oil priceExport of goods and services Imports of goods and services Current account Unemployment rateLoans to individuals
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Multivariate analysis: a binary choice model
Binary logit-models:
where
set of financial and macro factors
if the company is defaultotherwise
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Multivariate analysis
On the basis of selected financial indicators and macro variables, all possible multivariate models were built
The resulting combination was selected based on following criteria:• No significant correlation• Significance of indicators (t-statistic and
F-test)• The highest value Mc Fadden R2
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Best model (Mc Fadden R2=32%):
•Stocks in current assets, profitability of expenses, coefficient of autonomy and import are most risk sensitive
•Share of stocks in current assets was included in the quadratic form that led to increase of R2 by 2%
Multivariate analysis: results
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Quality of model – classification table
Classification table
Model results
Non default Default
Obs
erve
d Non default 84% (TN) 53% (FP)
Default 16% (FN) 47% (TP)
•Model better predicts no default cases•With the exclusion of macroeconomic
indicators the quality of the model decreases
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Thank you for your attention!