Estructura administrativa de México

Webber (2007) notes that corporate bonds have a higher yield than government bonds - the difference is known as the corporate bond spread. The corporate bond spread can be broken down as follows:

Corporate bond spread = Expected credit loss + Credit risk premium

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Credit spread

+Term liquidity premium.

The expected credit loss is the probability that the corporate may default and only repay a proportion of the borrowing. The credit risk premium is the premium that investors demand for having the uncertainty of whether the corporate may default. The expected credit loss and credit risk premium can be thought of as the credit spread. The term liquidity premium is the premium that investors demand

to compensate them for market liquidity risk.

It should be noted that there is different views on what exactly makes up the corporate bond spread. Amato and Remolona (2003) note that it is difficult to ex- plain corporate bond spreads and the associated credit risk. They note the presence of the “credit spread puzzle” which is defined as the wide gap between corporate bond spreads and the expected default loss. Tsuji (2005) has looked at several eco- nomic factors to assess corporate bond spread including the business cycle. A good summary of the “credit spread puzzle” and a review of the literature can be found in Muir et al. (2007).

The corporate bond spread and the reference rate together would be an approxi- mation to the bank’s cost of borrowing from the wholesale money market. Wyle and Tsaig (2011) suggest comparing the swap curve to a published credit rating agency curve for financial institutions reflecting the target credit rating of the bank. This difference would be the corporate bond spread for financial instituions and include the term liquidity premium and an allowance for the bank’s credit spread. This is basically saying that the credit rating agency curve for a financial institution should be used as the appropriate FTP rate. The credit risk included will depend on the target credit rating of the bank. It does depend on the maturity of bonds that have been issued by the financial institution; it is often difficult to find bonds above 15 years maturity which would limit its use.

However, there is some doubt as to whether the bank’s own specific credit risk should be included in the FTP. Dermine (2013) argues that if you include the bank’s specific credit risk, then the bank will not be able to offer competitive rates to customers with a better credit rating than the bank and hence will only attract higher risk customers. Higher credit risk customers for the bank may increase the risks for the bank (though this will depend on the interest rates charged on the loans) and may result in the bank’s own credit risk needing to be raised. Hence this may result in a vicious cycle of increasing risk for banks. Therefore, he suggests that the FTP rate should be adjusted for the bank’s specific risk so that the bank will be incentivised to lend to lower credit risk customers.

Choudhry (2012) also states that bank’s specific credit risk should not be in- cluded. Choudhry (2014) explains that this is because credit risk is already assessed by the business units for customers so would effectively be double counting. How- ever, this could be adddressed by the business unit assessing credit risk in relation to the bank’s credit risk but this would be a significant change in practice.

If you do not include the bank’s own credit risk then the bank could be lending money out cheaper than it could borrow. This would result in the bank making a loss and over time could make the bank insolvent. Alternatively, you could include the bank’s own credit risk and then compare customers’ credit risk to the banks so it is not getting double counted. For customers with better credit ratings than the bank the credit adjustment will be negative. However provided the bank’s commercial margin is greater than the negative credit adjustment it will still be profitable and may help to reduce the bank’s credit rating in the future. Also including the bank’s credit risk represents the true cost of funds to the bank so it will be able to value the benefits of bringing in deposits better. In this approach, the bank will be making a conscious decision and will decide what is the appropriate risk and return for the business unit.

Plassmann (2015), Cadamagnani et al. (2015) and Pedersen (2012) all expect the bank’s specific credit to be included. CEBS (2010) notes that some banks have used the reference rate plus CDS as their FTP rate. This would include an estimate of the bank’s credit risk but does not account for the term liquidity premium.

Overall, there is no clear view on whether the bank’s credit risk should be in- cluded.