Question

Mizuho Bank loaned $100 million to Company X for a period of 5 years. The loan is supported by a collateral, in this case, the corporate’s building which is currently valued at $60 million. The bank’s credit department has assigned a borrower rating of BBB (this corresponds to a PD of 1.35% on the bank’s rating scale) and a facility rating of E (this corresponds to a LGD of 45% on the bank’s scale).

How much capital would Mizuho Bank need to set aside for the $100 million loan to Company X?

1. Find the risk weighted amount of this loan
2. Assume a minimum capital ratio of 10% (given capital ratio = minimum capital needed /RWA), what is the minimum amount of capital Mizuho Bank has to set aside just for this $100 mil loan?
3. If the borrower rating is a B, would your answer in b) increase or decrease? Why?
4. If the loan is unsecured (no collateral), would your answer in b) increase or decrease? Why?
5. If company X is to default, the answer you calculated in b) is the unexpected loss to Mizuho Bank. What about the expected loss? Can you calculate the expected loss based on the information provided?

Answer 1

Hi,

Here are your answers:

A) As per my research,

Here I will calculate EAD (Exposure at default). EAD means, the total value of risk a bank is exposed to when giving out loans, and the debtor fails to repay the same. It is also known as credit exposure calculation. Here the EAD is $100 Million.

In your question, you have given PD 1.35% and LGD 45%.

PD stands for Probability of Default by debtor (here I mean company X)

LGD stands for Loss Given Default.

So, I will find the expected loss by multiplying EAD*PD*LGD

100Million*1.35%*45% = $607,500.00

Hence, finally risk weighted amount of this loan is $607,500.00 (RWA)

B) Minimum capital ratio given – 10%

Given capital ratio = minimum cap needed/ RWA

So, 10% = min. capital needed/607500

Comes to - $60,750.00

C) Amount will increase as rating B means a decreased rating.

D) Amount will increase in calculation of answer B, because without security there is a greater risk.