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Credit Risk In A Model World Bob Scanlon. Credit Risk In A Model World Backtesting Volatility of capital Database Rating requirements Consistency of rating.

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Presentation on theme: "Credit Risk In A Model World Bob Scanlon. Credit Risk In A Model World Backtesting Volatility of capital Database Rating requirements Consistency of rating."— Presentation transcript:

1 Credit Risk In A Model World Bob Scanlon

2 Credit Risk In A Model World Backtesting Volatility of capital Database Rating requirements Consistency of rating Parameters for portfolio risk

3 Impact of Loan Portfolio MTM Introduction: The movement towards marking to market loan portfolios will have a significant impact on P&L volatility. The principle drivers will be; -volatility in credit spreads. -the nature of the portfolio, in terms of credit rating and the tenor of the loans.

4 Impact of Loan Portfolio MTM A hypothetical 5 year $25bn loan portfolio has been modelled to show the impact of changes in credit spreads;

5 Benefits of using robust, well-validated rating models Consistent: All factors inherent in ratings are imputed into final ratings via universally- accepted benchmarks Unbiased: Subjective judgement can be consistently applied within the rating process. Transparent: Models provide a complete description of methodology employed Coverage: Ability to assess corporates and banks beyond coverage of the major rating agencies. Efficiency: Ratings can be quickly generated using extensive on-line databases. Use in Credit Assessment RATING MODELS HAVE NOW BEEN DEVELOPED SUFFICIENTLY TO BE USED FOR STAND-ALONE RATINGS

6 CRS is an integrated system Implementation CRS EMPLOYS ON-LINE FINANCIAL DATA TO GENERATE RATINGS BASED ON A PROVEN RATING METHODOLOGY

7 Sample Output

8 Process of Development DEVELOPMENT OF CRS IS AN EVOLUTIONARY PROCESS, AND NOT PURELY QUANTITATIVE Development involves significant analytical evaluation and feedback

9 Methodology Quantitative models must be supportive to the analysis of credit risk Cannot be a black box – needs to be sufficiently transparent to allow interpretation of output Need for compatibility with benchmarks used within internal rating process CHOICE OF APPROACH IS BASED ON SEVERAL CRITERIA, BUT MUST BE SIMPLE !!

10 CRS IS A HYBRID APPROACH WITH MODELS DEFINED BY SECTOR AND JURISDICTION Approaches Used Input to the models

11 HIGH CORRELATIONS BETWEEN VARIABLES ALLOW DEVELOPMENT OF SIMPLE, BUT EFFECTIVE MODELS Example - US food retailing Fundamental Data

12 Example - Profits and Financial Strength Rating for European Banks NON-LINEAR METHODS ARE NECESSARY FOR OPTIMAL MODEL PERFORMANCE

13 CRS HAS BEEN VALIDATED USING SEVERAL APPROACHES, RATHER THAN A SIMPLE ONE ANSWER APPROACH Model Validation Comprehensive validation should employ a multi-faceted approach

14 Analysis of rated defaults shows similar ratings at near default Correspondence between CRS and public ratings by looking at ratings for a portfolio of names one year prior to default. Default Prediction CRS DEFAULT EXPERIENCE Source: Moodys Default Risk Service

15 Impact of Size STABILITY OF KEY DRIVERS, SUCH AS SIZE, IS CRITICAL TO USE ON DISPARATE PORTFOLIOS Example – Impact of asset size on model performance for chemicals

16 Credit Risk In A Model World Once adopted how do you integrate model use for Credit decisions Exposure methodology Profit / risk maximisation minimisation or risk/reward Control or business function

17 Credit Risk In A Model World Limit homogenisation Weighted approach Benchmarks New deals into portfolio Immunisation Credit derivatives ? Next generation

18 Credit Risk In A Model World Out-performance through monitoring Parameter adjustment Staffing levels Information inputs Fall back process Prayers


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