Credit risk encompasses default risk (for instance, a debtor has not met his or her legal obligations according to the debt contract, see National Bank Regulations tab), migration risk (stemming from adverse movements in internal or external ratings) and country risk(he/she cannot per perform or pay because of events or measures taken by political and monetary authorities).
With respect to Basel Regulation, many banks chose to develop their own estimates of credit risk parameters: Probability of Default (PD), Loss Given Default (LGD), Exposure at Default (EAD). Business & Decision Risk Technology Consulting has gained solid experience by developing models for the Internal Ratings Based Approach (IRBA) at different customers. With proven years of experience in the effective implementation of quantitative models, Business & Decision can assist you in the requirements, development, recalibration and validation of credit risk models.
For the implementations we used tools such as:
Models developed for the risk computation have to be revalidated regularly.
On one side, the second pillar of Basel regulation implies that supervisors check that risk models are always performing consistently. On the other side, recent crisis has drawn the attention of internal stakeholders of the bank (business, CRO) to a higher interest on the models.
The validation process consists in a review of the development process and all related aspects of model implementation. It can be split in two parts:
In the credit risk context, the validation process concerns the three parameters: probability of default (PD), the exposure at default (EAD) and the loss given default (LGD). For each of those three, a complete backtesting is done at three levels:
In this three x three matrix (parameters x levels), each component has one or more standardized test to process. Business & Decision Risk Technology Consulting can implement those tests and provide all needed reporting.
In the counterparty credit risk context, one must take into consideration the uncertainty of exposure and the bilateral nature of risk. Hence, exposure at default is replaced by expected positive exposure (EPE) and effective expected positive exposure (EEPE). The test consists in comparing the observed P&L with EEPE (violations should be moderate, and the “pass” rate should not exceed a predetermined level, for instance 70%. For illustrations, we provided the following example:
The Belgian regulator, the National Bank of Belgium (NBB) insists that appropriate conservative measures be taken to compensate for the shortcomings of value and risk models. For instance, the NBB requires that there be an assessment of model risk, based on an inventory of:
Business & Decision Risk Technology Consulting can provide you the necessary functional and technical knowledge to evaluate the model risk.
With proven years of experience in the effective implementation of quantitative models, Business & Decision Risk Technology Consulting an assist you to manage models from strategic, usage and operational angles. More precisely, Risk Technology consultants can help you to:
Business & Decision Risk Technology Consulting can assist with the technical and functional expertise in the key points of model development:
To get to know the challenges of the ECB's AnaCredit Regulation and how Business & Decision proposes to address them practically:
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