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CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors.

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Presentation on theme: "CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors."— Presentation transcript:

1 CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. Copyright (c) 2006 Standard & Poors, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved. QUANTITATIVE MODELS WITHIN BASEL 2 S&P RS CRT GREECE Luca Martino, Associate Director, Client Solutions and PM Europe Standard & Poors Risk Solutions December 14, 2006 Athens

2 2. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. The implementation of Basel 2 in Greece will yield significant benefits because of its effects on the risk profile and the risk management systems of banks in the evaluation of their capital adequacy. Therefore, both from a supervisory and a financial stability perspective, the difficult task of implementing Basel 2 in Greece will be well worth the effort. (1) Within this context, Standard & Poors Risk Solutions (S&P RS) and a group of selected Greek banks covering nearly 70% of total banking assets, have agreed on a sponsorship program to develop Credit Risk Tracker Greece, a systemic credit risk model for the assessment of the credit quality of small to medium sized enterprises (SMEs) in Greece. S&P RS leverages the analytical skills and credit knowledge developed from 140 years of credit assessment experience at Standard & Poors. S&P RS benefits also from having developed country and industry based quantitative and expert judgement credit risk models in order to provide clients with a most complete credit estimate methodology and tools to enhance their internal credit risk systems in line with what S&P RS considers to be consistent with the risk management best practices and New Basel 2 Accord requirements. 1) Extract from a speech by the Governor of Bank of Greece, Mr. Nicholas C. Garganas Executive Summary

3 3. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. Bis2 Risk Analytics and Pricing Tool Risk Weighted Average Capital Calculator Collateral Management Optimisation PILLAR I Effectively Managing Economic Capital Cost and R.O.I. implications as important concerns Pressure from the Market and Rating agencies PILLAR II and III From REGULATORY CAPITAL to ECONOMIC CAPITAL REGULATORY CAPITAL Ensuring the risk is reflected in regulatory ratios Enhancing the credit process Better pricing credit lines with client Improving the credit quality of the banking book ECONOMIC CAPITAL Better quantifying risk on a prospective basis Facilitating more effective benchmarking between various business lines Making better decisions Assessing capital adequacy Regulatory Purposes Management Purposes The Regulatory and Business context

4 4. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. The Bis2 Challenge and Opportunity Critique of Basel 1Industry Advances with Basel 2 Basel 2 is responding to a need for regulatory reforms and advances in risk measurement and management. Encourages higher-risk lending (e.g. low-quality corporate) Undifferentiated pricing for risk in corporate lending by many institutions Risk-free perception of asset management and deposit-taking businesses Widespread regulatory arbitrage (e.g 364-day revolving loans and CLOs) Risk measurement –Credit rating market standard –Focus on operational risk and other risks –Inter-risk correlation –Economic Capital Credit risk transfer technology via product innovation and sophisticated portfolio modelling Risk- and value-based management –Pricing for economic capital –Process redesigns –Capital allocation and performance measurement

5 5. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. The European banking sector is currently facing a challenging crucial phase as the deadline for the implementation of Basel 2 New Regulation (1) approaches. The Basel 2 objective of financial stability assessment is basically to review the main sources of risks and vulnerabilities likely to affect the stability of the financial sector and to evaluate its capacity to absorb the impact of adverse disturbance. (2) Greece has undoubtedly a lot of potential with regard to its banking activity, which has been liberalised since 90s. In fact, while NPLs and Provisions/NPLs ratios are converging to better quality standards, average Tier 1 and Total Capital adequacy ratio for Greek banks is well above the average in the rest of the Euro zone. 1) See International Convergence of Capital Measurement and Capital Standards, June 2004 – Bank for International Settlements. 2) Extract from a speech by the Governor of Bank of Greece, Mr. Nicholas C. Garganas The Bis2 Challenge and Opportunity

6 6. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. Confidential information is firewalled between Risk Solutions and all other areas of Standard & Poors (e.g., Ratings Group). Risk Solutions is a non-Ratings business of Standard & Poors. Risk Solutions Structured Finance Ratings Corp. & Govt. Ratings Securities Services Standard & Poor's Credit Market Services S&P Risk Solutions – Corporate Structure

7 7. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. Lack of publicly available data No public markets No common language of credit risk (i.e., AAA) Best source of information (financial statements) only available once a year. Challenges to evaluating SMEs

8 8. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. How can we reduce costs and improve process? –Intuitiveness and usability –Standardization –Integrability (internally and external) –Scalability –Precise How do we employ credit risk best practices? –Accurate measure of credit risk –Timely appropriation of new information –Objective credit evaluations –Transparent methodology –Powerful Challenges to evaluating middle market

9 9. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. CRT facilitates a quantitative framework for greater precision in aligning risk and return. Back office –Regulatory/Economic capital calculations –Portfolio analysis –Credit monitoring. Front office –Target Marketing –Loan origination (yes/no) –Risk Adjusted pricing (granularity) –Securitization (CLO, CDO). Advantages of a Quantitative Framework

10 10. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. Credit Risk Tracker (CRT) is a suite of probability of default (PD) models for private companies. –Modeling framework (MEU) consistent across models. –CRT models are trained and validated on domestic data. Captures country default idiosyncrasies Empirical validation studies publicly available. –Probability of Default (PD) output comparable across models. Apples to apples Facilitates internal, external communication of credit quality. –Incorporates macroeconomic data. Stress PDs to economic shocks. Credit Risk Tracker

11 11. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. Banks dominate the Greek financial sector (+/- 85% of assets) and the banking sector itself is characterized by relatively high concentration with the 5 largest banks controlling the largest majority of the total assets. Specific structural factors, like the strong GDP growth in recent years, the increased liquidity for credit institutions consequent to the reduction of reserve requirements by Bank of Greece, the reduction of nominal and real interest rates and the increase in competition following the recent abolition of the remaining restriction on credit, are likely to have an impact on credit risk management requirements together with the need for an alignment to supervisory measures under Basel 2. More specifically, in the Greek context, credit risk is the main component of banking risk. Capital adequacy has recently improved again in 2003 and 2004 to a ratio of around 12%, remaining well above the minimum regulatory requirement of 8%. However, the share of banks with a core capital adequacy ratio of below 9% rose from a little above 1% in 2001 to about 10 % at end Because of this, products like CRT Greece which are able to assess the credit quality of assets within the loans related banking book enhancing thus the risk management process of banks, are in high demand. The Greek potential

12 12. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. For the development of CRT Greece, S&P RS has established sponsor relationships with the major Financial Institutions in Greece covering nearly 70% of the total banking assets. The sponsor banks will provide their internal default data, a key ingredient of a PD model like CRT Greece. Default information is going to be kept confidential between Risk Solutions and the participating Banks. The unique Tax Code Id of the companies is going to be encrypted and matched with the default data provided by the banks. The data provider is Hellastat, a young dynamic company established in 2000 by ex PricewaterhouseCoopers consultants. Clients include Citibank, NBG etc. The Regulator is the Bank of Greece. S&P RS will lead the project of the development of CRT Greece. S&P RS CRT Greece – Main players

13 13. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. The statistical development of CRT Greece involves a series of work steps as illustrated below. In order to reach superior figures in terms of performances CRT Greece will be developed using the most advanced statistical techniques and a rigorous analytical review of the numerical evidences within a general scrupulous modelling framework that will embrace all the relevant phases, from the collection and cleaning of raw data to the selection and calibration of the final model. S&P RS CRT Greece – Modelling Greek SMEs

14 14. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. As the economic environment changes and the portfolio of firms that CRT Greece will score is dynamic, it is essential to continuously monitor model's performance. S&P RS will review CRT Greece performances at least on an annual basis. Validation of models results, also referred to as back-testing or benchmarking, consists of ensuring that the model's expected performance indexes, like the Wealth Growth Rate Pickup (WGRP), the Gini and the ROC curves, meet minimum standards, in addition to ensuring that the model is reasonably well calibrated. We will also consider model performances within sub-groups (e.g., size groups, NACE codes, regions) to ascertain if there is a systemic bias present. S&P RS CRT Greece – On-going validation

15 15. CONFIDENTIAL AND PROPRIETARY. Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poors. To successfully implement Basel 2, Greek banks need to further improve their risk measurements and management systems. This will enable them to react more promptly and effectively to disturbances affecting their risk profile. Basel 2 represents not only the necessity of a regulatory compliance, as it is often said, but also an opportunity for credit institutions, irrespective of their size and complexity, to upgrade their risk management systems with the ultimate goal of supporting their business. Thanks to this valuable partnership with Greek financial institutions and data provider, S&P RS will provide the Greek banking system with the most complete methodology for credit estimation and an accurate suite of rating tools to enhance their internal rating systems in line with what S&P RS considers to be consistent with the risk management best practices already established in the rest of Europe and the upcoming new regulation. Credit Risk Tracker Greece will serve as a reference tool for PDs and quantitative derived rating estimates for SMEs, as well as the first Greek database of risk estimates for SMEs, enhancing banks core processes like credit management and active loan portfolio management. CONCLUSIONS


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