PDF Ebook Credit Risk Stress-Testing: The Case of a Real Estate Crisis
In most OCDE countries, banks incurred big credit losses in the aftermath of the previous real estate market crashes. This took place in the context of the sharp economic downturn of the early nineties. In some countries, the business cycle was even driven by the real estate cycle. The latter was exacerbated by investors’ speculative behaviour and commercial banks’ generous lending policies. Considering the big proportion of loans collateralized by real estate, it is important for commercial banks to understand the dynamics of real estate markets when monitoring their credit portfolios. Their qualitative credit risk management is usually complemented by the estimation of the credit loss distribution under adverse ’real estate conditions’. With a real estate stress-test, banks try to assess how much they would loose if a real estate crisis happened again. The original contribution of this paper is to present a new methodology for credit risk stress-testing based on a credit portfolio model. After an overview of the real estate markets dynamics, we analyse the credit portfolio’ sensitivity to real estate prices .Then, by using a generic credit portfolio model and a synthetic loan portfolio, we discuss the concept of risk concentration. Finally, our stress-testing approach is described using the generic model and compared to the standard approach by estimating stress loss distributions for the synthetic portfolio.
Even though a bubble in real estate (RE) markets could appear independently of the business cycle, these markets have proved to be highly pro-cyclical and the worst crisis encountered in the past were the pro-cyclical ones. In order to understand the RE markets preponderance within the economic cycle, we will first explain which factors are the main determinants of the RE price movements and the way structural conditions impact on the efficiency of RE markets and on their sensitivity to the monetary policy. We will then describe past RE crises which happened in four advanced countries (Japan, France, United Kingdom and Norway) about a decade ago. All these crises were clearly pro-cyclical and provoked by similar factors, but the structural economic conditions of these countries enable us to distinguish different mechanisms. Finally, we will focus our attention on Switzerland by highlighting the particularities of the housing and mortgage markets in the first place and by proposing two plausible RE stress scenarios for Switzerland in the future, one of which being classically pro-cyclical and a second one involving the removal of restrictive laws on housing property for foreign people.
CONTENTS
Part 1 - The Real Estate Crisis
1.1 Introduction
1.2 Real Estate Economics
- • Stylised facts on RE prices dynamic
• Real estate markets and the business cycle
• The ’housing wealth effect’
• Could the monetary policy harness the RE cycle ?
• Evolution of commercial real estate markets
• How to feel the emergence of a bubble
1.3 Past Crises
- • The Japanese disaster (1990-2000)
• Irrational expectations in Paris (1988-1993)
• The small & medium banks’ crisis in UK (1991-1992)
• The Norwegian Crisis (1988-1993)
1.4 The Swiss Case
- • The early nineties crisis
• Current situation
• Prospective ’stress’ scenarios
1.5 Conclusion
Part 2 - Credit Portfolio’ Sensitivity to Real Estate
2.1 Introduction
2.2 Transmission Mechanisms
- • Retail mortgages
• Income-producing mortgages
• What else ?
2.3 The Credit Portfolio Model
- • Standard multi-assets Merton framework
• Random effect approach for the calibration
• Monte-Carlo simulation
2.4 Discussion about Risk Concentration
- • A ’caricatured’ portfolio
• Results from the simulation
2.5 Conclusion
3 Part 3 - Credit Risk Stress-Testing
3.1 Introduction
3.2 The Standard Approach
3.3 An Alternative Approach
- • The recession stress-test
• The sectoral stress-test
3.4 Numerical Examples
3.5 Conclusion
Appendixes
Appendix A: Past Real Estate Crises in OCDE Countries
Appendix B: Nice Histograms
References
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PDF Ebook Credit Risk Stress-Testing: The Case of a Real Estate Crisis
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