Retail Loans & Basel II : Using Portfolio Segmentation to Reduce Capital Requirements

This paper presents a new technique for grouping retail loans into homogenous risk pools, which adheres to the provisions of Basel II. We use recursive partitioning and test it on a data set of approximately 413,000 auto loans. By classifying loans according to selective predictors of default, we find that banks can achieve significant savings in terms of a lower regulatory capital requirement. Alternatively, this provides the opportunity to increase lending capacity