Research Discussion Papers, Bank of Finland
Transmission of macro shocks to loan losses in a deep crisis: the case of Finland
(), Matti Viren
() and Oskari Vähämaa
Abstract: Building on the work of Sorge and Virolainen (2006), we
revisit the data on aggregate Finnish bank loan losses from the corporate
sector, which covers the ‘Big Five’ crisis in Finland in the early 1990s.
Several extensions to the empirical model are considered. These extensions
are then used in the simulations of the aggregate loan loss distribution.
The simulation results provide some guidance as to what might be the most
important dimensions in which to improve the basic model. We found that
making the average LGD depend on the business cycle seems to be the most
important improvement. We also compare the empirical fit of the annual
expected losses over a long period. In scenario-based analyses we find that
a prolonged deep recession (as well as simultaneity of various macro
shocks) has a convex effect on cumulative loan losses. This emphasizes the
importance of an early policy response to a looming crisis. Finally, a
comparison of the loan loss distribution on the eve of the 1990s crisis
with the most recent distribution demonstrates the greatly elevated risk
level prior to the 1990s crisis.
Keywords: credit risk; bank loan losses; banking crisis; macro shocks; default rates; stress testing; (follow links to similar papers)
JEL-Codes: C15; E37; G01; G21; G32; G33; (follow links to similar papers)
31 pages, November 2, 2009
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