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The Research on Loan Pricing of Commercial Banks Based on the KMV Model

Author: LiJing
Tutor: YangJunLong
School: Anhui University
Course: Finance
Keywords: lending rates KMV model loan pricing pricing methods based onRAROC credit risk
CLC: F832.4
Type: Master's thesis
Year: 2014
Downloads: 5
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Abstract

On the eighth meeting of the Third Plenary Session in2013, financial reform is considered to be the most important topic at the meeting. As the basic price index of financial markets, interest rates become an important aspect of reformation of the financial system. Interest rate liberalization has become the basic requirement to achieve the market economy. People’s Bank of China recently set up3objectives. Among them, the short-term goal is canceling the lower limit of the lending rate and establishing an independent pricing mechanism. Currently, this goal has been completed in July2013. At the same time, the quotation of the initial interest rate also has started running.The series of financial policy have made process of interest rate liberalization steadily and rapidly. However, on the entire financial sector in China, especially to the commercial banking, it is both a challenge and an opportunity. Numerous studies show that enriching loan pricing research and improving the ability of independent pricing will benefit for commercial banks which can advance the establishment of a credit management system with times. So commercial banks can obtain a competitive advantage to achieve the ultimate business objectives and sustainable development. Thus, the domestic commercial banks mostly chose appropriate mode of differential pricing, such as establishing relevant databases and quantitative model, to distinguish different credit status of the borrower, and then determine the level of interest rates based on the risk of the loans freely.Now, I believe that the credit risk is a direct factor affecting the quality and recovery of loans, and also affecting the stable operation of the banks. So studying the credit risk is the breakthrough about studying loan pricing. KMV model is the most widely used to measure credit risk. Through a series of documents and data analysis, I chose KMV model to analyze credit risk by building loan pricing model based on the measurement of credit risk. KMV model is a dynamic model based on option pricing theory, and measures listed company’s credit risk through asset value and volatility, equity value and volatility. It calculates the probability of default and the distance to default, and then deduces the risk premium. The model is very popular for its accuracy and effectiveness to measure credit risk, especially for lack of credit institutions and credit dates currently in China.On the other hand, the risk premium is only one aspect of loan pricing. Calculating lending rates also need to be adjusted by other factors about borrowing company and lending banks. In this paper, I select the pricing methods based on RAROC which comes from the traditional interpretation. The initial interest rate is summed together by the rate of cost of capital, operating cost rate, expected loss and economic capital ratio. It is essential that the expected loss rate is the risk premium derived by KMV model. Data required in this way is easy to find and the method is high feasibility.In this paper, I study the focus and the difficulties of loan pricing through using a combination with empirical research and theory. I firstly lay the theoretical foundation by introducing the background, significance and representatives of pricing methods, and chose the pricing methods based on RAROC. Then I need to systematically expound credit risk of commercial bank and deduce KMV loan pricing model in detail, because KMV model is based on a risk analysis to discuss the differential pricing. In the terms of practice, I test the loan pricing model and contrast valid results through quantitative and statistical analysis methods after I randomly select and calculate different years of a listed company’s financial data. Finally I concluded that KMV loan pricing model can be a rational response to the credit status of business in different stages and the result of lending rate is in line with the trends of company and bank. KMV model also demonstrates the advantages and disadvantages of pricing strategies. Then I put forward the suggestion about KMV model in application to find a perfect, practical and efficient loan pricing.

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CLC: > Economic > Fiscal, monetary > Finance, banking > China's financial,banking > Credit
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