Browsing by Subject "capital requirement"

The bank as a business tries to maximize the profit measured by the return on allocated capital (ROAC). This measure is calculated by dividing net income on capital allocated, thus the bank should both maximize net income and minimize capital allocated on the portfolio. The idea of the research is to check whether the higher return on allocated capital may be achieved if a bank calculates a capital requirement based on an internal ratings-based (IRB) approach instead of a standardized approach. The research question hypothesizes that the introduction of the IRB approach may lower the capital allocated on the retail portfolio, as the bank currently uses a standardized approach for the capital requirement calculation. In case the hypothesis is valid, the introduction of the IRB model lowers minimum capital requirements and through it, the higher ROAC is achieved. The capital requirement under the IRB approach is calculated through the estimation of the probability of default (PD) and loss given default (LGD) based on the bank's historical data. Probability of default is estimated using logistic regression and for loss given default estimation, the simple linear formula is applied due to unavailability of relevant data. The research proves that the application of the IRB approach significantly lowers bank's capital requirement and as a result increases its return on allocated capital.