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Applying Credit Risk Models to Deposit Insurance Pricing: Empirical evidence from the Italian banking system

by Aurelio Maccario of the Unicredit Banca Mobiliare & UniversitÓ "LUISS-Guido Carli",
Andrea Sironi of the UniversitÓ "Luigi Bocconi", and
Cristiano Zazzara of Capitalia & UniversitÓ "LUISS-Guido Carli"

August 2003

Abstract: The Federal Deposit Insurance Corporation (FDIC) has recently tested credit risk measurement models used by large international banks to measure the risk of their credit portfolios in order to measure the risk of default of its portfolio of insured banks. Using both balance sheet and equity market data for a sample of 15 large Italian banks, this study applies a credit value at risk model to estimate both individual and portfolio default risks for the Fondo Interbancario di Tutela dei Depositi (FITD), the Italian deposit insurance fund. The empirical analysis allows us to estimate the loss probability distribution of the FITD exposures which in turn can be used to: (i) evaluate the FITD fund adequacy; (ii) estimate the marginal contribution to the whole portfolio risk of an individual insured bank; (iii) test an alternative risk-.adjusted deposit insurance pricing scheme to the more traditional one based on option pricing models. Two main results emerge from the empirical analysis. First, the estimated total risk-based premium for the sample banks is in line with the current practice of the FITD and with its available callable capital. Second, significant differences appear to exist in the pricing of the deposit insurance service for the different sample banks. Such differences reflect both differences in the banks' individual risk profiles and the higher impact that the exposures to larger banks present on the risk profile of the FITD portfolio.

JEL Classification: G21, G28, G11, G33.

Keywords: Credit risk, deposit insurance, value at risk, risk-based pricing.

Published in: Journal of International Banking Regulation, Vol. 6, No. 1, (October 2004), pp. 10-32.

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