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1 Evaluation of the expected and unexpected losses of rolling stock leasing businesses

The proposed New Accord (Basel Committee on Banking Supervision) on capital requirement allows banks to calculate the minimum capital requirement using an Internal Rating-Based approach (IRB) that relies on credit risk models. Nevertheless, no studies have been conducted on leasing credit risk. This paper focuses on credit risk modelling issues of lease portfolios. We propose specific solutions dealing with the most important peculiarities of these portfolios, including their large size, the ownership of the leased assets by the lessors and the limited availability of information about the financial situation of lessees. We estimate the probability density function of losses and VaR measures in a portfolio of 35,861 rolling stock leases issued between 1990 and 2000 by a subsidiary of a well-known European financial institution. Our main results show that leasing represents a low-risk activity, especially when time after issuance is far from the origination date of the lease. Our study should go some way towards defining a benchmark for an adequate weighting ratio for the capital requirements of leasing businesses. We establish a comparison between our results and the requirements derived from the Basel Committee’s proposal which uses Internal Rating-Based approaches. It is apparent that the capital needed to cover losses can differ greatly according to the segment studied. In our view, the Internal Rating-Based Foundation Approach is of questionable value for leasing businesses since default of a lease contract does not necessary generate a loss. It can be concluded that the leasing business should give more attention to defining capital adequacy ratio and should provide for the decomposition of portfolios according to maturity and age of leases, since exposures, default rates and recovery rates (and hence the risk) vary accordingly.