Credit risk management and basel-II implementation of banks' corporate loans

Basel Committee on Banking Supervision has developed and releasedBasel-II standards. These standards change measurement of credit risk andinclude operational risk in calculation of capital adequacy. The reason behindthis development was the fact that supervisors of the most of developed anddeveloping countries accept more risk sensitive approaches to calculatecapital adequacy of banks. In recent years, the European Community hasmade significant changes in its banking legislation, mainly directives of2000/12/EC and 1993/6/EC, and candidate countries such as Turkey arerequired to adopt their legislation at lasted with the membership. Banks andthe regulatory authority in Turkey have been working on Basel-II intensivelyand have announced a road map for the implementation of Basel-IIstandards.In this thesis, alternative techniques of credit risk measurement arediscussed in terms of corporate portfolios. Then, related provisions of Basel-IIare addressed. The lack of adequate data limited the range of the study. Ifocus on price data and financial tables of reel sector companies listed inIstanbul Stock Exchange to estimate the probability of default (PD) during1997-2003. A rating methodology is developed based on the estimatedprobability of default. Defaulted firms are determined by using our definitionof default. The method of Receivers Operating Characteristics is used tovalidate the model, and the relationship between firm sizes and theirprobabilities of default is examined. Furthermore, probability of defaultindicators for each sector and economy in general are calculated andcompared with economic cycles. A hypothetical corporate portfolio isdesigned by using bank loans of the firms included in the analysis. Thisportfolio is, in turn, used to calculate capital requirement and provisionsunder the rules of Basel-I, the standard approach and the fundamentalinternal rating based approach on Basel-II.