Capital Allocation for Securitizations with Uncertainty in Loss Prioritization
by Michael Gordy of the Federal Reserve Board, and
December 6, 2002
Abstract: This paper sets forth a simple method for estimating the credit risk economic capital associated with securitization exposures, which are defined as credit exposures created by repackaging the cash flows from a pool of assets into various tranches or asset-backed securities. Our approach is motivated by the need for an effective and easily implemented regulatory capital rule for securitization exposures. Consequently, it is designed to be fully compatible with the model underpinning the Basel Committee's (2001) proposed Internal Ratings-Based Approach ("IRBA") to regulatory capital requirements against whole loans and other bank assets. Cost-effective application to a wide variety of securitizations and participating institutions dictates that our approach be parsimonious, in the sense of using minimal information on the contents of the securitized pool and on the contractual design of the securitization, as well as computationally tractable.