Recovery Rates of Bank Loans: Empirical Evidence for Germany

by Jens Grunert of the University of Mannheim, and
Martin Weber of the Centre for Economic Policy Research

March 2005

Abstract: Only few studies exist concerning the recovery rate of bank loans. The recovery rate is defined as the payback quota of a defaulted borrower. Prediction models of recovery rates are gaining in importance because of the Basel II-reform and the impact for the credit risk management, the calculation of interest rates and the results of credit risk models.

Factors that influence the recovery rate can be divided into the groups features of the borrower, intensity of the business connection, terms of credit and macroeconomic factors. According to the literature, the impact of the company size and the quota of collateral can be confirmed. Not yet analyzed is the detected influence of the probability of default, the intensity of the business connection and the sum of discounted outpayments. The found negative correlation between the probability of default and the recovery rate is important because the commonly used formula to calculate standard risk cost determines an expected loss that can be too low. Furthermore, this correlation leads to an underestimation of credit risk of credit risk models.

Published in: Journal of Banking & Finance, Vol. 33, No. 3, (March 2009), pp. 505-513.

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