Can Loan Valuation Adjustment (LVA) approach immunize collateralized debt from defaults?

Abstract

This study focuses on structuring tangible asset backed loans to inhibit their endemic option to default. We adapt the pragmatic approach of a margin loan in the configuring of collateralized debt to yield a quasi-default-free facility. We link our practical method to the current Basel III (2017) regulatory framework. Our new concept of the Loan Valuation Adjustment (LVA) and novel method to minimize the LVA converts the risky loan into a quasi risk-free loan and achieves value maximization for the lending financial institution. As a result, entrepreneurial activities are promoted and economic growth invigorated. Information asymmetry, costly bailouts and resulting financial fragility are reduced while depositors are endowed with a safety net equivalent to deposit insurance but without the associated moral hazard between risk-averse lenders and borrowers.