Bank’s Asset Quality Review Using Debt Service Coverage Ratio: An Empirical Investigation Across European Firms

In the asset quality review (AQR) framework, bank authorities have defined several financial measures for use to determine loan portfolio risk, and consequently, the adequate level of provisioning and capitalization. In concrete terms, with regard to a firm’s loans, the AQR exercises and ECB non-performing loans (NPLs) guidelines highlight a strict dependence between provisions and some financial and economic ratios. Among them, the debt service coverage ratio (DSCR) is largely used to detect the firm’s ability to repay its debts. In this chapter, the authors analyse the structure and economic meaning of the DSCR, in particular suggesting a dynamic approach to the DSCR, using a simple stochastic model. They also provide a general picture of the creditworthiness of the larger European firms, and consequently, of the intrinsic quality of European banks’ loans.