Retail Loans' Economic Capital Allocation Based On Gradient Method

The recent international financial crisis was caused by America's subprime mortgage crisis, revealed many banks had not pay sufficient attention to the risk of personal housing mortgage loans and asset securitization, which deserve deeply reflection. At present, many banks are expanding their retail loan businesses in the consideration of market demand and developing strategy. Therefore, it is necessary to strengthen the control the risk of retail loans. This paper discussed the effective economic capital allocation method to improve risk management in retail loans of commercial banks.This paper extended the gradient method of capital allocation to the domain of economic capital allocation, which mainly to solve the capital allocation problem for retail loans. Firstly, the paper introduced the content of economic capital allocation and analyzed the basic principles of capital allocation, and probe into the feasibility of extended gradient method to the domain of economic capital allocation, then discussed the way to implement economic capital allocation of retail loans from the perspective of banking branches. We have to divide different asset sub-pools because retail loans are massive and small amount, then calculate risk exposure according to BaselⅡconsidering retail loans in same pool are homogeneous. we can calculate the total occurred economic capital of any branch based on revised CreditRisk+model, then by applying gradient method, we can derive risk contribution of unit asset in each asset pool.On the basis of the above research, consider new occupied economic capital of alternative retail loan. For each alternative retail loan, we can obtain its per unit risk contribution according to corresponding asset pool, and calculate occupied economic capital according to the amount of risk exposure. Using this results and RAROC method, in the constraint of economic capital limitation, we will select optimal alternative loans, which ensuring the economic capital been allocated to low-risk and high-yield assets and realizing the value maximization of banks.