Full paper available here.
Georges Duponcheele, Alexandre Linden, William Perraudin, and Daniel Totouom-Tangho
This paper presents a calibration of the Conservative Monotone Approach (CMA), a model of capital for securitisation tranches, and shows how it may be used as the basis for regulatory capital. The CMA is risk-sensitive and implementable by both investor and originator banks. We explain how regulatory judgement may be exercised in the calibration so as to yield a conservative set of tranche capital charges.
The definition of tranche capital employed by the CMA is based on the tranche Marginal Value at Risk (MVaR). Basing capital on the MVaR ensures that capital per dollar of par always decreases as the seniority of the tranche rises, a desirable feature for a regulatory capital framework.
The CMA is non-neutral when compared to the on-balance-sheet capital (which, under the Basel II rules, bases capital on Unexpected Losses rather than MVaR). Specifically, the CMA requires more capital for all the tranches of a deal than is required under the loan capital charges for the underlying pool. Importantly, the CMA is transparent about the degree by which it deviates from capital neutrality in that the deviation equals the Expected Loss of the pool assets (after adjustment for the pool’s Future Margin Income and inclusive of a risk premium).