Measuring of Inferred Loss Rate with Application to Capital Adequacy

The loss rate of a bank’s portfolio traditionally measures what portion of the exposure is lost in case of default. To overcome the lack of private data and the difficulties involved in its computation, we introduce the notion of implied loss rate (ILR). We prove that ILR is sufficiently close to the actual loss rate in properties that facilitates capital adequacy analysis. To further demonstrate its usefulness, as an example, we estimate ILR for portfolios in the Bulgarian bank system using data on the quality of assets of bank groups reported by the Bulgarian National Bank.