Statistics for Retail Finance. Chapter 8: Regulation and Capital Requirements

Size: px
Start display at page:

Download "Statistics for Retail Finance. Chapter 8: Regulation and Capital Requirements"

Transcription

1 Statistics for Retail Finance 1

2 Overview > We now consider regulatory requirements for managing risk on a portfolio of consumer loans. Regulators have two key duties: 1. Protect consumers in the financial market place. 2. Provide the means for a stable and efficient financial market. Lenders must ensure they have sufficient capital to cover possible losses on a portfolio of loans. This is their capital requirement. 2

3 How much is a sufficient capital requirement? Well, the banks could cover every 1 lent with 1 of cash. o However, that would be an expensive and impractical solution. The usual solution is to cover some percentage of the loan value on the grounds that only a small percentage of the loans will go bad. o A usual figure in the past has been to have 8% of loan value as capital reserve. o This is a risk, however, since it is possible to under-estimate the number of bad loans. o Now, however, capital requirement is calculated based on measuring the risk of a portfolio of loans. 3

4 Risk on a portfolio of loans > We consider the loss on a portfolio (collection) of loans as a means to assess risk. Suppose we have loans. Then, Let { } denote default for observation ; Let denote loss given default (LGD) for observation ; Let denote exposure at default (EAD) for observation. LGD is the proportion of the loan that is recovered, whilst EAD is the amount exposed at default. Then individual loss is given as the product and total loss is 4

5 To understand risk, we need to develop a distribution for an estimate of total loss. This is not easy since separate models for each of the three components are required along with an understanding of their correlations: Default models are well-understood. However, models of LGD and EAD are still being developed. Although there is some evidence of a correlation between LGD and default, the size of the correlation is still not well-understood. 5

6 Expected Loss with fixed EAD and LGD > For this reason, often the loss is simplified by taking EAD and LGD as constant for all loans. Therefore, for all, we assume, for some fixed values. Define the default rate as Then, total loss is given by and expected loss (EL) on an individual is ( ) where ( ) is the probability of default (PD) for observation. 6

7 In the credit risk literature, this is usually written as Expected Loss = PD LGD EAD EL on a portfolio (collection) of loans is then given by where ( ) ( ) ( ) ( ) Therefore, EL can be computed using just a model of default, and PDs can be taken from a calibrated scorecard (eg using log-odds scores). 7

8 Variance of Default Rate > The EL does not tell us about the risk. Traditionally, in portfolio management, it is the variance that tells us about risk. We can compute variance on Default Rate: ( ) (( ) ) ( ( )) ( ) ( ) since. [ ( ) ( ( ) )] 8

9 Therefore ( ) [ ( ) ] where ( ). If we assume no covariance between observations, then this allows us to easily compute variance. However, this is not a reasonable assumption since defaults are likely to be correlated with each other. So we need to be able to estimate the covariance structure. 9

10 Value at Risk > Although variance gives a measure of risk, what is of most interest to lenders and regulators is that lenders can cover a large proportion of possible losses and in particular the extreme losses that might be experienced during a recession. For this reason, in credit risk management the focus is on estimating an upper quantile of the loss distribution. In Finance, this is known as the Value at Risk (VaR). Let be a cumulative distribution function on loss. Then, for a percentage ( ), ( ) ( ) Typical VaR are estimated at 99% or 99.9% levels. 10

11 So, VaR(99%) gives us an upper bound on 99% of possible losses. Therefore, it will only underestimate loss in 1% of cases. Please do not confuse VaR with Variance! 11

12 Example 8.1 This graph illustrates the loss distribution. It shows Expected Loss (EL) and VaR (99% level). VaR can be much larger than EL, especially when the loss distribution has a long right tail (this is usual) Loss (in million) Loss distribution Expected Loss VaR(99%) 12

13 Economic and Regulatory Capital > Economic capital is the capital a bank deems necessary to run its business. It will cover the Expected Loss, whilst allowing for unusually high losses. This is a matter for internal bank policy. Regulatory capital (RC) is the capital that regulators believe the banks need to keep against unexpected losses. There may be a cross-over with economic capital, but the calculation of RC is imposed by financial regulators. Each country has its own regulatory authority (eg Federal Reserve in the USA and Financial Services Authority in the UK). However, most countries now follow the Basel III rules set out by the Bank for International Settlements (BIS) in Switzerland. 13

14 Basel III > The Basel III Accords is an international agreement on bank regulation. It is composed of three Pillars : Pillar I: Calculation of Regulatory Capital (RC). Pillar II: Supervisory procedure; ie the powers regulators should have in working with banks. Pillar III: Financial market discipline; this ensures banks disclose critical information to enable an efficient financial market. Most of Basel is about Pillar I, and that is also what we are interested in. 14

15 Basel III Regulatory Capital (Pillar I) > Basel III allows banks to calculate RC in one of three ways. Standard approach; Internal-ratings based (IRB) approach: foundational; Internal-ratings based (IRB) approach: advanced. The standard approach follows the traditional method of setting RC as a percentage of loan amount (Basel I). However, it is not quite so simplistic since different types of loans require a different percentage to be set aside based on risk levels of the loan type. Both IRB approaches allow banks to use their own risk models to determine RC. This is attractive since it allows knowledge about a specific credit product to inform the RC computation. Since models of default are so well-established in the industry, both approaches require banks to provide 15

16 estimates of PD. However, since LGD is less well-understood, the foundational approach allows banks to use a fixed value of LGD provided by the regulator. Additionally both approaches allow banks to use an estimated value for EAD. To summarize: RC approach Bank estimate required? PD LGD EAD Standard No No No IRB foundational Yes No May be used IRB advanced Yes Yes Yes The major banks have chosen to use one of the IRB approaches. 16

17 Basel IRB Regulatory Capital calculation > In Basel III, RC is simply calculated as the difference between the VaR and EL. It therefore covers all unexpected losses ; ie losses that could occur in extreme conditions. Therefore, ( ) ( ) Note that ( ) is expected to be covered by provisioning and pricing of the credit product by the lender. We can easily compute ( ), but a loss distribution is required to compute VaR. o As we have seen, this is a problem since we need to estimate the correlation structure between default events. 17

18 One Factor Model > We cannot realistically model all possible correlations between accounts. Instead, we assume portfolio invariance; ie that there is one factor that governs the correlation between default events. Additionally, we use Merton s (1974) assumption: A borrower will default if the borrower s assets fall below the value of debts. Suppose we want to measure risk of default for an individual over a period of time. For each borrower, Let be the fixed debt over that period. Let be fixed assets at the start of the period. Let period. be a random variable representing assets at the end of the 18

19 Assume that the difference in asset values is normally distributed: ( ) Then model this difference using a one factor model where ( ) is a common systematic factor, scaled by and ( ) is an idiosyncratic factor scaled by, such that and are independent and the s are independent, and. This is known as a Merton-type model. 19

20 Notice that this model assumes that changing assets is associated with a combination of A common systematic factor ; and An idiosyncratic factor which depends on the individual. The common factor represents changing economic or social conditions which are universal to everyone in the loan portfolio. 20

21 Asset Correlation > We are interested in the correlation coefficient between the assets for two different borrowers. This is given by ( ) It turns out this correlation coefficient is a constant. This is known as the asset correlation. Theorem 8.1. For all observations,. Proof. ( ) ( ) ( ) ( ) since and are independent. 21

22 Theorem 8.2. For all observations and such that, Proof. ( ) (( )( )) ( ) ( ) ( ) ( ) since ( ), ( ) and and are independent. Therefore, ( ), since each and are independent. The result then follows using Theorem 1. 22

23 PD in Merton s Model > Remember Merton s assumption: A borrower will default if assets fall below the value of debts. We can now use this to estimate PD. It is the probability that assets at the end of the period are less than the debt: ( ) ( ) ( ) ( ) where is the cumulative standard normal distribution, since ( ). 23

24 Conditional PD > PD is then derived conditional on the value of factor : ( ) ( ) ( ) ( ) ( ) ( ( ) ) Notice this is a latent variable model, since values of needed to extract PD. are not actually 24

25 Loss Distribution on PD > The loss distribution on PD is then constructed on the random variable ( ). All that is needed to get a specific loss distribution is 1. An estimate of usual PD; We can use a standard scorecard model to do that, and 2. An estimate of the asset correlation. In Basel III, VaR is computed at the 99.9% level (so RC is underestimated with only a 1/1000 chance). We adjust to account for that. Larger is linked to higher assets, therefore we take the lowest 0.1 percentile. Since ( ), this is ( ) ( ). 25

26 Therefore, the VaR on PD at 99.9% is ( ( )) ( ) ( ( ) ( ) ) Basel II also specifies asset correlations. For instance, =0.04 for revolving credit; =0.15 for residential loans. These asset correlations have been estimated based on historic data. By considering loss at the individual level, if we fix LGD and EAD, RC is then given by ( ) ( ) ( ( ) ) 26

27 RC (per unit of EAD) Statistics for Retail Finance Example 8.2 The following graph shows the shape of RC, per unit of EAD, with LGD= PD Revolving credit Residential loans So, for instance, if a residential loan has PD=0.02, then RC= for every 1 of the loan. 27

28 Criticism of Merton-type models for consumer credit > There have been several criticisms of the Merton model as used in consumer credit. 1. The Merton model was originally designed for corporate loans. In that context it makes sense. It was used for consumer loans because no satisfactory alternative models were available for consumer credit. 2. The Merton assumption may not apply in consumer credit. Do all borrowers wait until asset value falls below debt before defaulting? In particular, many defaulters are those that simply won t pay, even if they have assets. Indeed, evidence suggests that for individuals (rather than corporation) cash-flow affects default, rather than overall assets. 3. Estimates of asset correlation have been criticized. It is not clear how they have been estimated, and it is suggested they have been set too high. 28

29 Exercise 8.1 In the usual one factor model for consumer credit, difference in assets a borrower is modelled by for where ( ) is a common factor scaled by, ( ) is an idiosyncratic factor scaled by, and and are independent and the s are all independent. a) Show that the correlation coefficient between difference in assets and for two borrowers and is for all and such that, where. Suppose the one factor model is modified so that there is a fixed correlation between the idiosyncratic factors. That is, the correlation coefficient between and for all and such that is given by. 29

30 b) Show that with this modification, the correlation coefficient between difference in assets and for two borrowers and is for all and such that. c) Express the probability of default (PD) conditional on the realization of, ( ), in terms of the unconditional PD,, and. d) Fixing values of, and, describe the effect of different values of [ ] on ( ). In particular, what is ( ) at the extremes of the range: and? 30

31 Stress Testing > In Pillar II, regulators also have powers to stress test banks, to determine how they will respond to extreme recessionary circumstances. Regulators expect banks to be able to survive extreme, but plausible, economic conditions. There are three general approaches to stress testing: 1. Analytic: Use a parametric loss distribution to compute extreme risk; 2. Scenarios: Either historic scenarios or designed by economists; 3. Simulation: Based on a dynamic model of default. 31

32 The 2 nd and 3 rd approach both rely on models that allow inclusion of extreme conditions to determine how this changes Expected Loss. For example, a survival model of default could be built with macroeconomic variables as time varying covariates (TVCs). Then risk of default is then a function of macroeconomic conditions. The scenario approach (2 nd ) produces one point estimate of effect on Expected Loss for each scenario. The simulation approach (3 rd ) will use Monte Carlo simulation to generate a distribution of Expected Loss based on a multivariate distribution of plausible economic scenarios. The scenario approach has the advantage that it reflects realistic historical conditions. The simulation approach, however, is able to take account of plausible but not historic conditions. Something to think about: Is one economic crisis just like another???? 32

33 If a distribution-based approach is used (either 1 st or 3 rd methods above) then extreme loss is considered as the loss beyond VaR. This is called expected shortfall (ES) and defined as ( ) ( ( )) That is, ES is the expected value of loss in the most extreme highestpercentile of values. 33

34 This graph shows the loss distribution with scenarios and ES also included Loss (in million) Loss distribution Expected Loss VaR(99%) ES(99%) region ES(99%) Scenarios 34

35 Example 8.3 The FSA has published an anchor scenario which can be used for stress testing. It specifies a series of economic conditions over a period of years of a recession. Therefore, a bank would need to determine how their portfolio of loans would behave over those years. Unemployment GDP CRE HPI FTSE All-Share Year Year Year Year Year CRE = Commercial Real Estate and HPI = House Price Index Note: Values for GDP, CRE, HPI and FTSE represent annual change. Source: These figures are correct as of January

36 Review of Chapter 8 > We have covered the following topics on regulation and capital requirements. Capital Requirements Loss Distribution Value at Risk Basel III Accord One Factor / Merton Model Stress Testing 36

Regulatory and Economic Capital

Regulatory and Economic Capital Regulatory and Economic Capital Measurement and Management Swati Agiwal November 18, 2011 What is Economic Capital? Capital available to the bank to absorb losses to stay solvent Probability Unexpected

More information

1) What kind of risk on settlements is covered by 'Herstatt Risk' for which BCBS was formed?

1) What kind of risk on settlements is covered by 'Herstatt Risk' for which BCBS was formed? 1) What kind of risk on settlements is covered by 'Herstatt Risk' for which BCBS was formed? a) Exchange rate risk b) Time difference risk c) Interest rate risk d) None 2) Which of the following is not

More information

Dr Christine Brown University of Melbourne

Dr Christine Brown University of Melbourne Enhancing Risk Management and Governance in the Region s Banking System to Implement Basel II and to Meet Contemporary Risks and Challenges Arising from the Global Banking System Training Program ~ 8 12

More information

Non-Bank Deposit Taker (NBDT) Capital Policy Paper

Non-Bank Deposit Taker (NBDT) Capital Policy Paper Non-Bank Deposit Taker (NBDT) Capital Policy Paper Subject: The risk weighting structure of the NBDT capital adequacy regime Author: Ian Harrison Date: 3 November 2009 Introduction 1. This paper sets out,

More information

Managing Capital Adequacy with the Internal Capital Adequacy Assessment Process (ICAAP) - Challenges and Best Practices

Managing Capital Adequacy with the Internal Capital Adequacy Assessment Process (ICAAP) - Challenges and Best Practices Managing Capital Adequacy with the Internal Capital Adequacy Assessment Process (ICAAP) - Challenges and Best Practices An Oracle White Paper January 2009 OVERVIEW In addition to providing guidelines for

More information

Regulatory Stress Testing For Mortgage Loan Portfolios

Regulatory Stress Testing For Mortgage Loan Portfolios Regulatory Testing For Mortgage Loan Portfolios Introduction testing of loan portfolios is a concept that has been around for many years, but as an outgrowth of the credit crisis, stress testing has become

More information

Basel Committee on Banking Supervision. An Explanatory Note on the Basel II IRB Risk Weight Functions

Basel Committee on Banking Supervision. An Explanatory Note on the Basel II IRB Risk Weight Functions Basel Committee on Banking Supervision An Explanatory Note on the Basel II IRB Risk Weight Functions July 2005 Requests for copies of publications, or for additions/changes to the mailing list, should

More information

Profit from Big Data flow. Regulatory Stress Testing For Mortgage Loan Portfolios. 2013 by Opera Solutions, LLC. All rights reserved.

Profit from Big Data flow. Regulatory Stress Testing For Mortgage Loan Portfolios. 2013 by Opera Solutions, LLC. All rights reserved. Profit from Big Data flow Regulatory Testing For Mortgage Loan Portfolios Regulatory Testing For Mortgage Loan Portfolios Introduction testing of loan portfolios is a concept that has been around for many

More information

Statistics in Retail Finance. Chapter 6: Behavioural models

Statistics in Retail Finance. Chapter 6: Behavioural models Statistics in Retail Finance 1 Overview > So far we have focussed mainly on application scorecards. In this chapter we shall look at behavioural models. We shall cover the following topics:- Behavioural

More information

Consultation Paper: Review of bank capital adequacy requirements for housing loans (stage one).

Consultation Paper: Review of bank capital adequacy requirements for housing loans (stage one). Consultation Paper: Review of bank capital adequacy requirements for housing loans (stage one). The Reserve Bank invites submissions on this Consultation Paper by 16 April 2013. Submissions and enquiries

More information

Stress-Testing a UK Retail Bank

Stress-Testing a UK Retail Bank Stress-Testing a UK Retail Bank Executive Summary This article discusses stress and scenario testing the mechanism through which firms understand and prepare for a range of realistic adverse circumstances.

More information

arxiv:1412.1183v1 [q-fin.rm] 3 Dec 2014

arxiv:1412.1183v1 [q-fin.rm] 3 Dec 2014 Regulatory Capital Modelling for Credit Risk arxiv:1412.1183v1 [q-fin.rm] 3 Dec 2014 Marek Rutkowski a, Silvio Tarca a, a School of Mathematics and Statistics F07, University of Sydney, NSW 2006, Australia.

More information

Basel Committee on Banking Supervision. Working Paper No. 17

Basel Committee on Banking Supervision. Working Paper No. 17 Basel Committee on Banking Supervision Working Paper No. 17 Vendor models for credit risk measurement and management Observations from a review of selected models February 2010 The Working Papers of the

More information

Financial-Institutions Management

Financial-Institutions Management Solutions 3 Chapter 11: Credit Risk Loan Pricing and Terms 9. County Bank offers one-year loans with a stated rate of 9 percent but requires a compensating balance of 10 percent. What is the true cost

More information

PRA Retail Credit Risk Non-UK Portfolio Quality Return January 2015

PRA Retail Credit Risk Non-UK Portfolio Quality Return January 2015 PRA Retail Credit Risk Non-UK Portfolio Quality Return January 2015 Guidance Notes Purpose of the Template The purpose of this template is to provide the PRA with a consistent dataset to help form an assessment

More information

Validation of Internal Rating and Scoring Models

Validation of Internal Rating and Scoring Models Validation of Internal Rating and Scoring Models Dr. Leif Boegelein Global Financial Services Risk Management Leif.Boegelein@ch.ey.com 07.09.2005 2005 EYGM Limited. All Rights Reserved. Agenda 1. Motivation

More information

IFRS 9 Expected credit losses

IFRS 9 Expected credit losses No. US2014-06 August 13, 2014 What s inside: Background... 1 Overview of the model... 2 The model in details... 4 Transition... 16 Implementation challenges... 17 Appendix: Illustrative examples... 18

More information

Remarks on Credit Card Stress Testing

Remarks on Credit Card Stress Testing Remarks on Credit Card Stress Testing Nicholas M. Kiefer Cornell University Departments of Economics and Statistical Science Stress Testing Model Symposium Federal Reserve Bank of Boston September 2012

More information

Basel II & Credit Risk Management: Risk Data and Modeling Considerations

Basel II & Credit Risk Management: Risk Data and Modeling Considerations Basel II & Credit Risk Management: Risk Data and Modeling Considerations Deloitte & Touche LLP History of Banking Capital and Basel The Basel Accord was initially drafted in 1988 to improve the safety

More information

CONTENTS. List of Figures List of Tables. List of Abbreviations

CONTENTS. List of Figures List of Tables. List of Abbreviations List of Figures List of Tables Preface List of Abbreviations xiv xvi xviii xx 1 Introduction to Value at Risk (VaR) 1 1.1 Economics underlying VaR measurement 2 1.1.1 What is VaR? 4 1.1.2 Calculating VaR

More information

Credit Score Basics, Part 1: What s Behind Credit Scores? October 2011

Credit Score Basics, Part 1: What s Behind Credit Scores? October 2011 Credit Score Basics, Part 1: What s Behind Credit Scores? October 2011 OVERVIEW Today, credit scores are often used synonymously as an absolute statement of consumer credit risk. Or, credit scores are

More information

A macroeconomic credit risk model for stress testing the Romanian corporate credit portfolio

A macroeconomic credit risk model for stress testing the Romanian corporate credit portfolio Academy of Economic Studies Bucharest Doctoral School of Finance and Banking A macroeconomic credit risk model for stress testing the Romanian corporate credit portfolio Supervisor Professor PhD. Moisă

More information

Basel Committee on Banking Supervision. Working Paper on the IRB Treatment of Expected Losses and Future Margin Income

Basel Committee on Banking Supervision. Working Paper on the IRB Treatment of Expected Losses and Future Margin Income Basel Committee on Banking Supervision Working Paper on the IRB Treatment of Expected Losses and Future Margin Income July 2001 Working Paper on the IRB Treatment of Expected Losses and Future Margin

More information

Monte Carlo Simulation

Monte Carlo Simulation 1 Monte Carlo Simulation Stefan Weber Leibniz Universität Hannover email: sweber@stochastik.uni-hannover.de web: www.stochastik.uni-hannover.de/ sweber Monte Carlo Simulation 2 Quantifying and Hedging

More information

Basel Committee on Banking Supervision

Basel Committee on Banking Supervision Basel Committee on Banking Supervision Reducing excessive variability in banks regulatory capital ratios A report to the G20 November 2014 This publication is available on the BIS website (www.bis.org).

More information

IMPLEMENTATION NOTE. Validating Risk Rating Systems at IRB Institutions

IMPLEMENTATION NOTE. Validating Risk Rating Systems at IRB Institutions IMPLEMENTATION NOTE Subject: Category: Capital No: A-1 Date: January 2006 I. Introduction The term rating system comprises all of the methods, processes, controls, data collection and IT systems that support

More information

Approaches to Stress Testing Credit Risk: Experience gained on Spanish FSAP

Approaches to Stress Testing Credit Risk: Experience gained on Spanish FSAP Approaches to Stress Testing Credit Risk: Experience gained on Spanish FSAP Messrs. Jesús Saurina and Carlo Trucharte Bank of Spain Paper presented at the Expert Forum on Advanced Techniques on Stress

More information

Stress testing and capital planning - the key to making the ICAAP forward looking PRMIA Greece Chapter Meeting Athens, 25 October 2007

Stress testing and capital planning - the key to making the ICAAP forward looking PRMIA Greece Chapter Meeting Athens, 25 October 2007 Stress testing and capital planning - the key to making the ICAAP forward looking Athens, *connectedthinking Agenda Introduction on ICAAP requirements What is stress testing? Regulatory guidance on stress

More information

COMMERCIAL BANK. Moody s Analytics Solutions for the Commercial Bank

COMMERCIAL BANK. Moody s Analytics Solutions for the Commercial Bank COMMERCIAL BANK Moody s Analytics Solutions for the Commercial Bank Moody s Analytics Solutions for the Commercial Bank CATERING TO ALL DIVISIONS OF YOUR ORGANIZATION The Moody s name is synonymous with

More information

Credit Risk Management: Trends and Opportunities

Credit Risk Management: Trends and Opportunities Risk & Compliance the way we see it Credit Risk Management: Trends and Opportunities The Current State of Credit Risk Management 1 Overview The crisis exposed the shortcomings of existing risk management

More information

Empirical Analysis of the Average Asset Correlation for Real Estate Investment Trusts

Empirical Analysis of the Average Asset Correlation for Real Estate Investment Trusts FEDERAL RESERVE BANK OF SAN FRANCISCO WORKING PAPER SERIES Empirical Analysis of the Average Asset Correlation for Real Estate Investment Trusts Jose A. Lopez Federal Reserve Bank of San Francisco October

More information

CAPITAL MANAGEMENT - FIRST QUARTER 2010

CAPITAL MANAGEMENT - FIRST QUARTER 2010 CAPITAL MANAGEMENT - FIRST QUARTER 2010 CAPITAL MANAGEMENT The purpose of the Bank s capital management practice is to ensure that the Bank has sufficient capital at all times to cover the risks associated

More information

Stress Test Modeling in Cards Portfolios

Stress Test Modeling in Cards Portfolios Stress Test Modeling in Cards Portfolios José J. Canals-Cerdá The views expressed here are my own and not necessarily those of the Federal Reserve or its staff. Credit Card Performance: Charge-off Rate

More information

Credit Risk Models: An Overview

Credit Risk Models: An Overview Credit Risk Models: An Overview Paul Embrechts, Rüdiger Frey, Alexander McNeil ETH Zürich c 2003 (Embrechts, Frey, McNeil) A. Multivariate Models for Portfolio Credit Risk 1. Modelling Dependent Defaults:

More information

Credit Scoring Modelling for Retail Banking Sector.

Credit Scoring Modelling for Retail Banking Sector. Credit Scoring Modelling for Retail Banking Sector. Elena Bartolozzi, Matthew Cornford, Leticia García-Ergüín, Cristina Pascual Deocón, Oscar Iván Vasquez & Fransico Javier Plaza. II Modelling Week, Universidad

More information

The Western Hemisphere Credit & Loan Reporting Initiative (WHCRI)

The Western Hemisphere Credit & Loan Reporting Initiative (WHCRI) The Western Hemisphere Credit & Loan Reporting Initiative (WHCRI) Public Credit Registries as a Tool for Bank Regulation and Supervision Matías Gutierrez Girault & Jane Hwang III Evaluation Workshop Mexico

More information

Skewness of returns, capital adequacy, and mortgage lending

Skewness of returns, capital adequacy, and mortgage lending Skewness of returns, capital adequacy, and mortgage lending Paraskevi Dimou Alistair Milne Colin Lawrence November 2003 The lady doth protest too much, methinks. Hamlet, Act 3, scene 2. Abstract This paper

More information

Bankruptcy and the Business Cycle: Are SMEs Less Sensitive to Systematic Risk?

Bankruptcy and the Business Cycle: Are SMEs Less Sensitive to Systematic Risk? Bankruptcy and the Business Cycle: Are SMEs Less Sensitive to Systematic Risk? Tor Jacobson Jesper Lindé Kasper Roszbach Conference on Small Business Finance World Bank, 6 May 2008 Tor Jacobson, Jesper

More information

Credit Risk in the Leasing Business

Credit Risk in the Leasing Business Credit Risk in the Leasing Business - A case study of low probability of default - by Mathias SCHMIT & DEGOUYS C. DELZELLE D. STUYCK J. WAUTELET F. 1 Université Libre de Bruxelles, Solvay Business School

More information

The credit risk in SME loans portfolios: Modeling issues, pricing, and capital requirements

The credit risk in SME loans portfolios: Modeling issues, pricing, and capital requirements Journal of Banking & Finance 26 (2002) 303 322 www.elsevier.com/locate/econbase The credit risk in SME loans portfolios: Modeling issues, pricing, and capital requirements Michel Dietsch *,1,Jo el Petey

More information

Division 9 Specific requirements for certain portfolios of exposures

Division 9 Specific requirements for certain portfolios of exposures L. S. NO. 2 TO GAZETTE NO. 43/2006 L.N. 228 of 2006 B3157 Division 9 Specific requirements for certain portfolios of exposures 197. Purchased receivables An authorized institution shall classify its purchased

More information

Portfolio Management for Banks

Portfolio Management for Banks Enterprise Risk Solutions Portfolio Management for Banks RiskFrontier, our industry-leading economic capital and credit portfolio risk management solution, along with our expert Portfolio Advisory Services

More information

State Farm Bank, F.S.B.

State Farm Bank, F.S.B. State Farm Bank, F.S.B. 2015 Annual Stress Test Disclosure Dodd-Frank Act Company Run Stress Test Results Supervisory Severely Adverse Scenario June 25, 2015 1 Regulatory Requirement The 2015 Annual Stress

More information

CP FOR DRAFT RTS ON RWS/LGDS ARTICLES 124 AND 164 CRR EBA/CP/2015/12. 6 July 2015. Consultation Paper

CP FOR DRAFT RTS ON RWS/LGDS ARTICLES 124 AND 164 CRR EBA/CP/2015/12. 6 July 2015. Consultation Paper EBA/CP/2015/12 6 July 2015 Consultation Paper Draft Regulatory Technical Standards on the conditions that competent authorities shall take into account when determining higher risk-weights, in particular

More information

Basel II. Tamer Bakiciol Nicolas Cojocaru-Durand Dongxu Lu

Basel II. Tamer Bakiciol Nicolas Cojocaru-Durand Dongxu Lu Basel II Tamer Bakiciol Nicolas Cojocaru-Durand Dongxu Lu Roadmap Background of Banking Regulation and Basel Accord Basel II: features and problems The Future of Banking regulations Background of Banking

More information

TD Bank Financial Group Q4/08 Guide to Basel II

TD Bank Financial Group Q4/08 Guide to Basel II TD Bank Financial Group Q4/08 Guide to Basel II 1. OVERVIEW General Information on Basel can be found on the Canadian Bankers Association website at www.cba.ca. Choose Issues, Standards, Rules and Guidelines

More information

Nationwide Building Society Treasury Division One Threadneedle Street London UK EC2R 8AW. Tel: +44 1604 853008 andy.townsend@nationwide.co.

Nationwide Building Society Treasury Division One Threadneedle Street London UK EC2R 8AW. Tel: +44 1604 853008 andy.townsend@nationwide.co. Nationwide Building Society Treasury Division One Threadneedle Street London UK EC2R 8AW Tel: +44 1604 853008 andy.townsend@nationwide.co.uk Uploaded via BCBS website 21 March 2014 Dear Sir or Madam BASEL

More information

Pillar 3 Disclosures. (OCBC Group As at 31 December 2014)

Pillar 3 Disclosures. (OCBC Group As at 31 December 2014) 1. INTRODUCTION The purpose of this document is to provide the information in accordance with Pillar 3 directives under Monetary Authority of Singapore ( MAS ) Notice 637 on Risk Based Capital Adequacy

More information

ICAAP Report Q2 2015

ICAAP Report Q2 2015 ICAAP Report Q2 2015 Contents 1. INTRODUCTION... 3 1.1 THE THREE PILLARS FROM THE BASEL COMMITTEE... 3 1.2 BOARD OF MANAGEMENT APPROVAL OF THE ICAAP Q2 2015... 3 1.3 CAPITAL CALCULATION... 3 1.1.1 Use

More information

Risk Management Structure

Risk Management Structure Commitment to Risk Management Basic Approach Progress in financial deregulation and internationalization has led to growth in the diversity and complexity of banking operations, exposing financial institutions

More information

Contents. List of Figures. List of Tables. List of Examples. Preface to Volume IV

Contents. List of Figures. List of Tables. List of Examples. Preface to Volume IV Contents List of Figures List of Tables List of Examples Foreword Preface to Volume IV xiii xvi xxi xxv xxix IV.1 Value at Risk and Other Risk Metrics 1 IV.1.1 Introduction 1 IV.1.2 An Overview of Market

More information

Low Default Portfolio (LDP) modelling

Low Default Portfolio (LDP) modelling Low Default Portfolio (LDP) modelling Probability of Default (PD) Calibration Conundrum 3 th August 213 Introductions Thomas Clifford Alexander Marianski Krisztian Sebestyen Tom is a Senior Manager in

More information

79 8.1. Capital requirement under Pillar I 81 8.2. ICAAP 81 8.2.1. Capital requirement under Pillar II 82 8.2.2. Internal assessment of capital

79 8.1. Capital requirement under Pillar I 81 8.2. ICAAP 81 8.2.1. Capital requirement under Pillar II 82 8.2.2. Internal assessment of capital 8. Capital management 79 8.1. Capital requirement under Pillar I 81 8.2. ICAAP 81 8.2.1. Capital requirement under Pillar II 82 8.2.2. Internal assessment of capital needed on the basis of economic capital

More information

CREDIT RISK MANAGEMENT

CREDIT RISK MANAGEMENT GLOBAL ASSOCIATION OF RISK PROFESSIONALS The GARP Risk Series CREDIT RISK MANAGEMENT Chapter 1 Credit Risk Assessment Chapter Focus Distinguishing credit risk from market risk Credit policy and credit

More information

The Role of Mortgage Insurance under the New Global Regulatory Frameworks

The Role of Mortgage Insurance under the New Global Regulatory Frameworks The Role of Mortgage Insurance under the New Global Regulatory Frameworks By Anna Whittingham Regulatory Analyst, Genworth Financial Mortgage Insurance Europe Summary and Overview The introduction of fundamental

More information

LDA at Work: Deutsche Bank s Approach to Quantifying Operational Risk

LDA at Work: Deutsche Bank s Approach to Quantifying Operational Risk LDA at Work: Deutsche Bank s Approach to Quantifying Operational Risk Workshop on Financial Risk and Banking Regulation Office of the Comptroller of the Currency, Washington DC, 5 Feb 2009 Michael Kalkbrener

More information

A Proven Approach to Stress Testing Consumer Loan Portfolios

A Proven Approach to Stress Testing Consumer Loan Portfolios A Proven Approach to Stress Testing Consumer Loan Portfolios Interthinx, Inc. 2013. All rights reserved. Interthinx is a registered trademark of Verisk Analytics. No part of this publication may be reproduced,

More information

CITIGROUP INC. BASEL II.5 MARKET RISK DISCLOSURES AS OF AND FOR THE PERIOD ENDED MARCH 31, 2013

CITIGROUP INC. BASEL II.5 MARKET RISK DISCLOSURES AS OF AND FOR THE PERIOD ENDED MARCH 31, 2013 CITIGROUP INC. BASEL II.5 MARKET RISK DISCLOSURES AS OF AND FOR THE PERIOD ENDED MARCH 31, 2013 DATED AS OF MAY 15, 2013 Table of Contents Qualitative Disclosures Basis of Preparation and Review... 3 Risk

More information

Measuring operational risk in financial institutions: Contribution of credit risk modelling

Measuring operational risk in financial institutions: Contribution of credit risk modelling CAHIER DE RECHERCHE / WORKING PAPER Measuring operational risk in financial institutions: Contribution of credit risk modelling Georges Hübner, Jean-Philippe Peters and Séverine Plunus August 06 / N 200608/02

More information

Counterparty Credit Risk for Insurance and Reinsurance Firms. Perry D. Mehta Enterprise Risk Management Symposium Chicago, March 2011

Counterparty Credit Risk for Insurance and Reinsurance Firms. Perry D. Mehta Enterprise Risk Management Symposium Chicago, March 2011 Counterparty Credit Risk for Insurance and Reinsurance Firms Perry D. Mehta Enterprise Risk Management Symposium Chicago, March 2011 Outline What is counterparty credit risk Relevance of counterparty credit

More information

2016 Comprehensive Capital Analysis and Review

2016 Comprehensive Capital Analysis and Review BMO Financial Corp. and BMO Harris Bank N.A. 206 Comprehensive Capital Analysis and Review Dodd-Frank Act Company-Run Stress Test Supervisory Severely Adverse Scenario Results Disclosure June 23, 206 Overview

More information

Stress Testing: Credit Risk

Stress Testing: Credit Risk Stress Testing: Credit Risk Joe Henbest Algorithmics, Inc. Paper presented at the Expert Forum on Advanced Techniques on Stress Testing: Applications for Supervisors Hosted by the International Monetary

More information

Despite its emphasis on credit-scoring/rating model validation,

Despite its emphasis on credit-scoring/rating model validation, RETAIL RISK MANAGEMENT Empirical Validation of Retail Always a good idea, development of a systematic, enterprise-wide method to continuously validate credit-scoring/rating models nonetheless received

More information

Assessing Credit Risk of the Companies Sector

Assessing Credit Risk of the Companies Sector Assessing Credit Risk of the Companies Sector Gerhard Winkler Annual Regional Seminar On Financial Stability Issues INTERNATIONAL MONETARY FUND and NATIONAL BANK OF ROMANIA Sinaia, Romania September 18-19,

More information

INTERNAL CAPITAL ADEQUACY ASSESSMENT

INTERNAL CAPITAL ADEQUACY ASSESSMENT INTERNAL CAPITAL ADEQUACY ASSESSMENT 30 june 2011 Contents Page 1. Introduction... 3 2. Process for determining the solvency need... 4 2.1. The basis for capital management... 4 2.2. Risk identification...

More information

Credit Scorecards for SME Finance The Process of Improving Risk Measurement and Management

Credit Scorecards for SME Finance The Process of Improving Risk Measurement and Management Credit Scorecards for SME Finance The Process of Improving Risk Measurement and Management April 2009 By Dean Caire, CFA Most of the literature on credit scoring discusses the various modelling techniques

More information

Mitchell H. Holt Dec 2008 Senior Thesis

Mitchell H. Holt Dec 2008 Senior Thesis Mitchell H. Holt Dec 2008 Senior Thesis Default Loans All lending institutions experience losses from default loans They must take steps to minimize their losses Only lend to low risk individuals Low Risk

More information

RESP Investment Strategies

RESP Investment Strategies RESP Investment Strategies Registered Education Savings Plans (RESP): Must Try Harder Graham Westmacott CFA Portfolio Manager PWL CAPITAL INC. Waterloo, Ontario August 2014 This report was written by Graham

More information

Over the past several years, the issuance of small business loan securitizations

Over the past several years, the issuance of small business loan securitizations Standard & Poor s Small Business Portfolio Model Introduces a Potential New Tool for Community Development Loan Risk Analysis* Weili Chen and Winston Chang Standard & Poor s Over the past several years,

More information

Corporate Credit Rating System Scope Document

Corporate Credit Rating System Scope Document Co-create. Innovate. Win. Corporate Credit Rating System Scope Document 1. EXECUTIVE SUMMARY 1 1.1 Introduction 1 1.2 Credit Rating and Basel II Compliance 1 1.3 Ramco Roadmap in Enabling Basel II Compliance

More information

Monitoring cyclicality of Basel II capital requirements

Monitoring cyclicality of Basel II capital requirements Financial Stability Paper No. 3 December 2007 Monitoring cyclicality of Basel II capital requirements James Benford and Erlend Nier Financial Stability Paper No. 3 December 2007 Monitoring cyclicality

More information

Edinburgh Research Explorer

Edinburgh Research Explorer Edinburgh Research Explorer Retail Credit Stress Testing Using a Discrete Hazard Model with Macroeconomic Factors Citation for published version: Bellotti, T & Crook, J 203, 'Retail Credit Stress Testing

More information

CRM Master Research Projects

CRM Master Research Projects CRM Master Research Projects Semi-Analytical Implementation for the Name Concentration Measurement in a Credit Portfolio Author: Sandra Alvarez Jordán Advisor: Luis Ortiz Gracia Master of Science in Advanced

More information

HSBC North America Holdings Inc. 2015 Comprehensive Capital Analysis and Review and Annual Company-Run Dodd-Frank Act Stress Test Results

HSBC North America Holdings Inc. 2015 Comprehensive Capital Analysis and Review and Annual Company-Run Dodd-Frank Act Stress Test Results 2015 Comprehensive Capital Analysis and Review and Annual Company-Run Dodd-Frank Act Stress Test Results Date: March 5, 2015 TABLE OF CONTENTS PAGE 1. Overview of the Comprehensive Capital Analysis and

More information

Market Risk Capital Disclosures Report. For the Quarter Ended March 31, 2013

Market Risk Capital Disclosures Report. For the Quarter Ended March 31, 2013 MARKET RISK CAPITAL DISCLOSURES REPORT For the quarter ended March 31, 2013 Table of Contents Section Page 1 Morgan Stanley... 1 2 Risk-based Capital Guidelines: Market Risk... 1 3 Market Risk... 1 3.1

More information

Residential Mortgage Portfolio Risk Analytics ROGER M. STEIN, ASHISH DAS

Residential Mortgage Portfolio Risk Analytics ROGER M. STEIN, ASHISH DAS Residential Mortgage Portfolio Risk Analytics ROGER M. STEIN, ASHISH DAS NOVEMBER 19, 2010 Agenda Why are mortgages complicated to model? Many (many) scenarios are required to capture the behavior of mortgages

More information

Basel Committee on Banking Supervision. Basel III counterparty credit risk - Frequently asked questions

Basel Committee on Banking Supervision. Basel III counterparty credit risk - Frequently asked questions Basel Committee on Banking Supervision Basel III counterparty credit risk - Frequently asked questions November 2011 Copies of publications are available from: Bank for International Settlements Communications

More information

Capital Ratio Information (Consolidated) Sumitomo Mitsui Financial Group, Inc. and Subsidiaries

Capital Ratio Information (Consolidated) Sumitomo Mitsui Financial Group, Inc. and Subsidiaries SMFG Capital Ratio Information (Consolidated) Sumitomo Mitsui Financial Group, Inc. and Subsidiaries The consolidated capital ratio is calculated using the method stipulated in Standards for Bank Holding

More information

Insights. Did we spot a black swan? Stochastic modelling in wealth management

Insights. Did we spot a black swan? Stochastic modelling in wealth management Insights Did we spot a black swan? Stochastic modelling in wealth management The use of financial economic models has come under significant scrutiny over the last 12 months in the wake of credit and equity

More information

RISK MANAGEMENT. Risk governance. Risk management framework MANAGEMENT S DISCUSSION AND ANALYSIS RISK MANAGEMENT

RISK MANAGEMENT. Risk governance. Risk management framework MANAGEMENT S DISCUSSION AND ANALYSIS RISK MANAGEMENT RISK MANAGEMENT Effective risk management is fundamental to the success of the Bank, and is recognized as one of the Bank s five strategic priorities. Scotiabank has a strong, disciplined risk management

More information

Bank Capital Adequacy under Basel III

Bank Capital Adequacy under Basel III Bank Capital Adequacy under Basel III Objectives The overall goal of this two-day workshop is to provide participants with an understanding of how capital is regulated under Basel II and III and appreciate

More information

Università della Svizzera italiana. Lugano, 20 gennaio 2005

Università della Svizzera italiana. Lugano, 20 gennaio 2005 Università della Svizzera italiana Lugano, 20 gennaio 2005 Default probabilities and business cycle regimes: a forward-looking approach Chiara Pederzoli Università di Modena e Reggio Emilia 1 Motivation:

More information

Counterparty Credit Risk Measurement Under Basel II. A presentation by ISDA Asia 2007

Counterparty Credit Risk Measurement Under Basel II. A presentation by ISDA Asia 2007 Counterparty Credit Risk Measurement Under Basel II A presentation by ISDA Asia 2007 1 Outline 1- Definition of counterparty credit risk (CCR) 2- Basel I treatment 3- Basel II treatment : Regulatory approved

More information

SEMINAR ON CREDIT RISK MANAGEMENT AND SME BUSINESS RENATO MAINO. Turin, June 12, 2003. Agenda

SEMINAR ON CREDIT RISK MANAGEMENT AND SME BUSINESS RENATO MAINO. Turin, June 12, 2003. Agenda SEMINAR ON CREDIT RISK MANAGEMENT AND SME BUSINESS RENATO MAINO Head of Risk assessment and management Turin, June 12, 2003 2 Agenda Italian market: the peculiarity of Italian SMEs in rating models estimation

More information

Basel II, Pillar 3 Disclosure for Sun Life Financial Trust Inc.

Basel II, Pillar 3 Disclosure for Sun Life Financial Trust Inc. Basel II, Pillar 3 Disclosure for Sun Life Financial Trust Inc. Introduction Basel II is an international framework on capital that applies to deposit taking institutions in many countries, including Canada.

More information

Basel III Pillar 3 CAPITAL ADEQUACY AND RISK DISCLOSURES AS AT 30 SEPTEMBER 2014

Basel III Pillar 3 CAPITAL ADEQUACY AND RISK DISCLOSURES AS AT 30 SEPTEMBER 2014 Basel III Pillar 3 CAPITAL ADEQUACY AND RISK DISCLOSURES AS AT 30 SEPTEMBER 2014 COMMONWEALTH BANK OF AUSTRALIA ACN 123 123 124 5 NOVEMBER 2014 1 Scope of Application The Commonwealth Bank of Australia

More information

APPLYING COPULA FUNCTION TO RISK MANAGEMENT. Claudio Romano *

APPLYING COPULA FUNCTION TO RISK MANAGEMENT. Claudio Romano * APPLYING COPULA FUNCTION TO RISK MANAGEMENT Claudio Romano * Abstract This paper is part of the author s Ph. D. Thesis Extreme Value Theory and coherent risk measures: applications to risk management.

More information

Enterprise Risk Management

Enterprise Risk Management Enterprise Risk Management Enterprise Risk Management Understand and manage your enterprise risk to strike the optimal dynamic balance between minimizing exposures and maximizing opportunities. Today s

More information

SAS Forum Switzerland Stress Testing. A Whistle-Stop Tour. Jörg Behrens Owen Matthews fintegral consulting

SAS Forum Switzerland Stress Testing. A Whistle-Stop Tour. Jörg Behrens Owen Matthews fintegral consulting SAS Forum Switzerland 2012 Stress Testing A Whistle-Stop Tour Jörg Behrens Owen Matthews Agenda Overview Modelling Implementation Q&A 2 Overview 3 Risk Management Regimes P&L distribution Time Scale Risk

More information

Pillar 3 Disclosure 2008

Pillar 3 Disclosure 2008 Pillar 3 Disclosure 2008 rbs.com Pillar 3 Disclosure 03 Background 05 Scope of application 06 Capital and risk management 09 Credit risk Credit risk management 10 Credit risk by IRB approach 14 Credit

More information

Quantitative Methods for Finance

Quantitative Methods for Finance Quantitative Methods for Finance Module 1: The Time Value of Money 1 Learning how to interpret interest rates as required rates of return, discount rates, or opportunity costs. 2 Learning how to explain

More information

TD Bank Financial Group Q1/08 Guide to Basel II

TD Bank Financial Group Q1/08 Guide to Basel II TD Bank Financial Group Q1/08 Guide to Basel II 1. OVERVIEW General Information on Basel can be found on the Canadian Bankers Association website at www.cba.ca. Choose Issues, Standards, Rules and Guidelines

More information

Behavior Model to Capture Bank Charge-off Risk for Next Periods Working Paper

Behavior Model to Capture Bank Charge-off Risk for Next Periods Working Paper 1 Behavior Model to Capture Bank Charge-off Risk for Next Periods Working Paper Spring 2007 Juan R. Castro * School of Business LeTourneau University 2100 Mobberly Ave. Longview, Texas 75607 Keywords:

More information

Fundamental Review of the Trading Book: A Revised Market Risk Framework Second Consultative Document by the Basel Committee on Banking Supervision

Fundamental Review of the Trading Book: A Revised Market Risk Framework Second Consultative Document by the Basel Committee on Banking Supervision An Insight Paper by CRISIL GR&A ANALYSIS Fundamental Review of the Trading Book: A Revised Market Risk Framework Second Consultative Document by the Basel Committee on Banking Supervision The Basel Committee

More information

Tail-Dependence an Essential Factor for Correctly Measuring the Benefits of Diversification

Tail-Dependence an Essential Factor for Correctly Measuring the Benefits of Diversification Tail-Dependence an Essential Factor for Correctly Measuring the Benefits of Diversification Presented by Work done with Roland Bürgi and Roger Iles New Views on Extreme Events: Coupled Networks, Dragon

More information

Practical Applications of Stochastic Modeling for Disability Insurance

Practical Applications of Stochastic Modeling for Disability Insurance Practical Applications of Stochastic Modeling for Disability Insurance Society of Actuaries Session 8, Spring Health Meeting Seattle, WA, June 007 Practical Applications of Stochastic Modeling for Disability

More information

Credit Risk Stress Testing

Credit Risk Stress Testing 1 Credit Risk Stress Testing Stress Testing Features of Risk Evaluator 1. 1. Introduction Risk Evaluator is a financial tool intended for evaluating market and credit risk of single positions or of large

More information

BASEL III PILLAR 3 CAPITAL ADEQUACY AND RISKS DISCLOSURES AS AT 30 SEPTEMBER 2015

BASEL III PILLAR 3 CAPITAL ADEQUACY AND RISKS DISCLOSURES AS AT 30 SEPTEMBER 2015 BASEL III PILLAR 3 CAPITAL ADEQUACY AND RISKS DISCLOSURES AS AT 30 SEPTEMBER 2015 COMMONWEALTH BANK OF AUSTRALIA ACN 123 123 124 5 NOVEMBER 2015 This page has been intentionally left blank Introduction

More information

SOUTHEAST EUROPE MORTGAGE FINANCE WORKING GROUP Sofia February 23, 2005

SOUTHEAST EUROPE MORTGAGE FINANCE WORKING GROUP Sofia February 23, 2005 SOUTHEAST EUROPE MORTGAGE FINANCE WORKING GROUP Sofia February 23, 2005 Who We Are Presentation Topics Credit Life Insurance Mortgaged Property Insurance Mortgage Insurance Who We Are The leading international

More information

Zsuzsanna Tajti: The methodological opportunities of quantifying the retail mortgage loan s LGD in Hungary

Zsuzsanna Tajti: The methodological opportunities of quantifying the retail mortgage loan s LGD in Hungary Zsuzsanna Tajti: The methodological opportunities of quantifying the retail mortgage loan s LGD in Hungary - 1 - Institute of Finance and Accounting Department of Investments and Corporate Finance Tutor:

More information