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The Risk-Weights in the New Basel Capital Accord: Lessons from Bond Spreads Based on a Simple Structural Model

by Andrea Resti of Bocconi University, and
Andrea Sironi of Bocconi University

May 2006

Abstract: The Basel Committee designed a system of risk weights ("standardised approach") to measure the riskiness of banks' loan portfolios. We investigate its ability to adequately reflect risk through an analysis of the economic capital implied in corporate bond spreads. This is based on a dataset of issuance spreads, ratings and other relevant bond variables including 7,232 eurobonds issued by an internationally-diversified sample during 1991-2003. Three main results emerge: the spread/rating relationship is strongly significant; the estimated spreads per rating class indicate a steeper risk/rating relationship than the one approved by the Basel Committee; no significant difference appears in the spread/rating relation of banks and non-financial firms issuers.

JEL Classification: G15, G21, G28.

Keywords: eurobonds, credit ratings, spreads, structural models, capital regulation, deposit insurance, banks.

Published in: Journal of Financial Intermediation, Vol. 16, No. 1, (January 2007), pp. 64-90.

Previously titled: The Basel Committee Approach To Risk-Weights And External Ratings: What Do We Learn From Bond Spreads?

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