A Research On Economic Capital Management And Credit Risk Control In International Commercial Banks

Since 1970s, twenty century, the deregulation and change in the business environment caused by the collapse of the Bretton Woods agreement has led to a fierce competition and the deterioration of the risk profile among the international commercial banks. The erosion of the bank capital by a series of debt and bank crisis aroused an extreme emphasis lay by the international regulation authorities on the bank capital, international commercial bank themselves also realize the extreme importance of the capital management for the controlling credit risk. To amend the flaws of the Basel Accord in the quantification of financial risk, international banks had developed internal models continuously in the expectation of precise risk quantification and controlling risk effectively, the definition of economic capital is innovated in this process. The merits and widely use of the economic capital management in international banks has made it the core of the modern risk management in international commercial banks.Economic capital management optimizes the allocation of the risk assets and perfect the portfolio through quantification, allocation and assess the capital use of each branch, business unit, trade and product, in order to increase the shareholder added value (SAV) stably and maximize the risk-adjusted return on capital (RAROC). The structure of this paper is consistent with the definition of the economic capital, addresses respectively the credit risk, the evolution of the credit risk management in commercial banks, the calculation and distribution of economic capital.. Finally, based on the reality in china and the revelation from the international banks, the paper provides several recommendations to the economic capital management in china.Besides forward,this theses can be divided into five parts. The first part introduces the credit risk commercial banks. Credit risk can be defined as: the risk incurred by the banks when the credit quality of the borrower or other obligors deteriorate and cause the debt or other contracts cannot be paid back when expire, it represents as default risk and credit rating migration risk. Generally, credit risk possess the following features: fat-tail and skewness of the credit risk distribution, hard to acquire continuous observed data for credit risk, hard to identify, obvious unsystematic feature. From the angle of Economics, the fundamental cause of credit risk is the uncertainty in economic activity. Besides, the asymmetry of information is another important cause. The research object of this thesis is international banks, so the unique risks for international banks are addressed.The second part of the thesis addresses the evolution of the capital management in commercial banks. Capital management in commercial banks can be divided into three classes, i.e. book capital management, regulatory capital management, economic capital management. The implementation of regulatory capital management represented by the Basel Accord increased the capital adequacy ratio to a quite large extent, and built a level competition field, controlled the irrational credit asset expansion. The inconsistence between regulatory capital and the real risk lead to an ineffective effort in decrease risk and a large amount of regulatory arbitrage activities. Economic capital management is the core of the modern risk management.The third part addresses in detail the modern credit risk economic capital calculation model and point out the development of modern financial theory and the emergence of the credit derivatives make revolutionary progress in the credit risk management in 1990s 20 century. The financial engineer experts introduce model building and analysis approach into credit risk management. Modern credit risk management model includes: KMV model developed by the KMV company, CreditMetrics developed by the JP Morgan, CreditRisk+ developed by Swiss Suisse, Credit Portfolio View developed by Mckinsey company.The fourth part of the thesis firstly addresses the evolution of the capital allocation methods and point out the flaws of the first two methods, i.e. traditional book profit system and the return on equity, and the method based on RAROC and it merits. Then, the thesis addresses in detail the relation between appraisal and capital allocation, then point out the essence of the process of capital allocation is to compare the achievements among the business units, calculate their contribution to the shareholder value added (SVA), then identify the business that create value, finally allocate the capital based on the conclusion. The process of capital allocation directs the business decision making at the same time and in this way maximizes the shareholder value. The fifth part of the thesis introduces the implementation of economic capital management in china and concludes we have enter the implementation stage. Then the thesis points out the problem of economic capital management in china, i.e. the technical standard is far from the level needed, the lack of data, the responsibility and coordination regime need to be clarified, the constrain of the risk asset is not formed, there still exists problems in the EVA appraisal. In order to learn from the advanced experiences of the international commercial banks, the thesis analyzes the suitability of the models for china and concludes through empirical analysis that the KMV model is to some extent usable in china. Considering the problem of capital management in china and the revelation from international banks the thesis point out we should enhance the collection and accumulation of data, set up and perfect the internal rating system, enhance the construction of management and information system, set up a appraisal and capital allocation system based on RAROC and EVA, and Classify the product more specifically when calculating the economic capital.