Pro Rata Credit Risk Pooling Between Regional Banks: Economic Capital and Portfolio Granularity

Abstract

German savings and cooperative banks use credit risk pooling transactions as a specific type of synthetic credit risk transfer. This paper describes the effect of pro rata credit risk pooling transactions on the granularity of these banks’ credit portfolios. The change in granularity is described analytically using general properties of concentration measures. This allows to prove independent of specific concentration measures or credit portfolio models that the granularity of a credit portfolio will increase if a bank participates in pro rata credit risk pooling with homogeneous credit risks. But simulations show that Value-at-Risk will not always decrease if a portfolio’s granularity increases, ceteris paribus. As a consequence, banks using Value-at-Risk instead of a coherent risk measure like Expected Shortfall might choose to limit their participation in credit risk pooling transactions.