Beyond Basel-2 simplified standardized approach: Credit risk valuation of short-term loan commitments

As alternative to Basel-2 coefficients, this research proposes markup-based risk weights for short-term credit commitments. To do this, Basel-2 credit-conversion and principal-risk factors are replaced by a duration-dependent takedown proportion and a commitment put option that accounts for the nonnormal features of the underlying credit-line marked-to-market value. Put value and takedown proportion are then combined to compute the 'fair' capital charge corresponding to the commitment 'true' credit risk. As benchmark, the option-based procedure is used next to assess the accuracy of Basel-2 accounting-based capital charges, impose some quasi-market discipline and align regulatory and economic capital requirements. The final step generalises the fair procedure to a new risk-weighting system, which also accounts for the borrowers' risk ratings of public credit agencies.