As a senior loan officer at MC Financial Corp, you have a loan application from a firm in the biotech industry. While the loan has been approved on the basis of an individual loan, you must evaluate the loan based on its impact on the risk of the overall loan portfolio. The FI uses the three methods to assess its loan portfolio risk.

1. Concentration Limits—The FI currently has lent an amount equal to 40 percent of its capital to the biotech industry and does not lend to a firm in any sector that generates losses in excess of 2 percent of capital. The average historical losses in the biotech industry total 5 percent.

2. Loan Volume–Based Model—National and MC Financial’s loan portfolio allocations are as follows.

MC Financial does not want to deviate from the national average by more than 12.25 percent.

3. Loan Loss Ratio–Based Model—Based on regression analysis on historical loan losses, the FI estimates the following loan loss ratio models:

where X_C&I = loss rate in the commercial sector, X_con = loss rate in the consumer (household) sector, X_L = loss rate for its total loan portfolio. MC Financial’s total increase in the loan loss ratio is expected to be 12 percent next year. Should MC Financial Corp. grant this loan?

Transcribed Image Text:

Allocation of Loan Portfolios in Different Sectors (%) Sectors National MC Financial Commercial 30% 40% Real Estate 50% 45% 15% Consumer 20%