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1、1Validation of Credit Risk Models 1March 2010Valere Baerts Business Architect CPFAGENDA21.From regulation to standard risk management1.A generic Model Management Framework2.Validation of a Credit Risk Model: the building blocks3.Summary and conclusionsAGENDA31.From regulation to standard risk manage
2、ment1.A generic Model Management Framework2.Validation of a Credit Risk Model: the building blocks3.Summary and conclusions4From regulation to standard risk managementBasel one, two, three . ?The Basel Accord(s) refers to the banking supervision agreements (recommendations and regulations), Basel I
3、(1988) and Basel II (2004) issued by the Basel Committee on Banking Supervision (BCBS). The Basel Accords are implemented in 100 countries worldwide. The Central Bank of Russia intends to implement also these accords but (amongst others) due to the financial crisis no exact planning is known (to me)
4、.5From regulation to standard risk managementWhat do these “accords” try to do?Quantitative element (called Pillar 1 in Basel II) Make sure that there is enough capital available in Bank for stress circumstances.The failure of a bank impacts the global financial system: links to other banks (Interba
5、nk market), credit crunch (macro economic effects) and “poor” depositors loosing their (part) of their savings. As a consequence, governments try to manage the risks in banks by requiring a minimum level of capital relative to its risk assets; in other words to place a limit on the ability of a bank
6、 to gear its balance sheet. Qualitative element (not in Basel I, called Pillar 2 and 3 in Basel II) Risk Governance (internal processes) and transparency (disclosure of data)6From regulation to standard risk managementHow is (regulatory) capital calculated?Depending on which Basel approach the Bank
7、chooses or has to use, there are 3 options to calculate capital:-Standard approach: for smaller not complex banks - values of parameters to calculate capital are predefined by regulators-Foundation and Advanced approach: for larger, more complex banks - values of (some) parameters to calculate capit
8、al are model based7From regulation to standard risk managementKey Drivers of credits (*) used as input into the capital calculation: - the borrowers probabilities of default (PD)( rating of borrower )(IRBF and IRBA) - loss given default (LGD) and exposure at default (EaD) on an exposure-by- exposure
9、 basis (IRBA and for retail portfolio also IRBF) - Maturity (IRBF and IRBA)(K) = LGD * N (1 - R)-0.5 * G (PD) + (R / (1 - R)0.5 * G (0.999) - PD * LGD * (1 - 1.5 x b(PD) -1 . (1 + (M - 2.5) * b (PD) Risk weighted assets = 12.5 * K * EAD(*) We call this key drivers as these parameters mainly determin
10、e the credit risk related to lending products (loans, credit cards ). As such using these parameters in your credit process is “good practice” independent if the bank applies Basel II or not !Credit RiskBorrower characteristicsFacility characteristicsWho are we lending to?Probability of DefaultHow m
11、uch exposure will we have should the borrower default?Time to contractual repayment?What is the % we expect to loose taken into account recovery on collateral?Exposure at DefaultMaturity Loss Given DefaultFrom regulation to standard risk management8Use of Key Drivers in Credit ProcessFrom regulation
12、 to standard risk management9How do we calculate the “Key Drivers” of Credit Risk? The drivers in essence classify the customer on a scale of creditworthiness and loss probability. how likely is it that the borrower will pay back his loan? PD what will the exposure be when borrower defaults? EaD wha
13、t will the loss be given the borrower defaults? LGDKey word in these questions is “will”, in other words we need to look into the future to find answers. The calculation of these drivers is equal to making a prediction. In general predictions can be “expert” based or “model” based in both cases howe
14、ver the output is mainly based on historical data ( the credit experts opinion is most likely influenced with experiences from the past) so finally the models arrived in our story10From regulation to standard risk management11From regulation to standard risk managementThe only thing we know about th
15、e future is that it will be different. (P. Drucker)A (any) model is a simplified version of reality. It is in general a theoretical construction that represents processes by a set of variables and their relationships (in case of credit risk models the process can be described as behavior of a custom
16、er related to repayment).What can go wrong with a model ( = model risk *) 1. Errors in the model development process (wrong data, assumptions,) 2. Errors in implementation of models (bugs) 3. Wrong usage of models Due to these shortcomings the bank will refuse good customers, accept bad customers, price products to cheap, build up a bad performing portfolio, calculate to high or to low provisions etc* Model ri
