The Canadian Olympic company has recently teamed up with a major Big Data Company to ramp up the analytics for the benefit of the athletes.
Recently the COC made an announcement about an eight-year, cash and services sponsorship deal with SAS, which is an analytics software with a brag-worthy client list from varied industries, like universities, hotels, banks casinos and much more.
The term credit risk encompasses all types of default risks that are associated with different financial instruments such as – (like for example, a debtor has not met his or her legal duties according to the debt contract), migrating risk (arises from adverse movements internally or externally with the ratings) and country risks (the debtor cannot pay as per the duties because of measure or events taken by political or monetary agencies of the country itself).
In compliance to Basel Regulations, most banks choose to develop their own credit risk measuring parameters: Probability Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD). Several MNCs have gathered solid experience by developing models for the Internal Ratings Based Approach (IRBA) for different clients.
The models that are built for the computation of risks must be revalidated on a regular basis.
On one hand, the second pillar of the Basel regulations implies that supervisors should check that their risk models are working consistently for optimum results. On the other hand, recent crises have drawn the focus of the stakeholders of the banks (business, CRO) to a higher interest on the models.
In the context of credit risk, the process of validation is concerned with three main parameters they are – probability of default (PD), exposure at default (EAD) and the loss given default (LGD). And for all of the above mentioned three a complete backresting is done at the three levels:
In the below three X three matrix (parameter X level) each and every component has had one or more standardized tests to process. With the right Credit Risk Modelling training an individual can implement all the above tests and provide for the needful reporting of the same.
In terms of the counterparty credit risk context, one must consider the uncertainty of exposure and the bilateral nature of the risk associated. Hence, exposure at the default can be replaced by the EPE (expected positive exposure) and EEPE (effective expected positive exposure).
The test include comparing the observed P&L with the EEPE (make sure the violations are moderate and the pass rate does not exceed a predetermined level for instance 70%).
As per the National Bank of Belgium, which is he Belgian regulator (NBB), it insists that appropriate conservative measures should be incorporated to compensate for the discrepancies of the value and risk models. For example, as per the NBB requisites there should be an assessment of the model risk, which is based on the inventory of:
A quality Credit Risk Management Course can provide you with the necessary functional and technical knowledge to assess the model risk.
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The incident we are about to describe took place during 2009 circa at a party, a year in which the world was going through one of its worst financial crisis for the longest time. Every average bloke on the streets was aware of terms like mortgage-backed securities (MBS), sub-prime lending and credit crisis, after all these are the reasons for his plight.
But at this party we are speaking of, I was fortunate enough to meet with an informed and highly compassionate elderly woman, and after a few minutes of discussion the topic came to what we here do for a living. She wanted to know more about credit scorecard systems. As I further went on to explain the details of how this system works, her expression changed from being just plainly curious to angry to pained. Continue reading “Introduction To Credit Score Cards: Its Use in Crisis”
Having discussed some amount of mandatory regulatory compliances for banks over the past couple of blogs, let us now focus on the bank’s lines of business. Understanding the different banking products is inevitable for credit risk management and analytics. One has to be well versed with the nature of banking products before they step in to develop model for any of them. Each banking product has its own characteristics and its own set of risk exposure. Hence, understanding these products is the top priority. In this blog we discuss three of the major banking products: Checking Accounts, Savings accounts and Certificate of Deposits.
Checking Accounts: This is a transactional deposit account held at a financial institution that allows for withdrawal and deposits. Money held in a checking account is liquid, and can be easily withdrawn using checks, automated cash machines, and electronic debits among other methods. It allows for numerous withdrawals, unlimited deposits etc. These accounts are known as current accounts in UK. These are often loss leaders for large commercial banks since they become highly commotized. Because money held in checking accounts is so liquid, aggregate balances nationwide are used in the calculation of M1 money supply. Continue reading “Banking Business and Banking Instruments”
While the developed nations are slowly recovering from the financial chaos of post depression, the credit risk managers are facing growing default rates as household debts are increasing with almost no relief in sight. As per the reports of the International Finance which stated at the end of 2015 that household debts have risen to by USD 7.7 trillion since the year 2007. It now stands at the heart stopping amount of a massive USD 44 trillion and the amount of debts increased in the emerging markets is of USD 6.2 trillion. The household loans of emerging economies calculating as per adult rose by 120 percent over the period and are now summed up to USD 3000.
To thrive in this market of increasing debts, credit risk managers must consider innovative methods to keep accuracy in check and decrease default rates. A good solution to this can be applying the data analytics to Big Data. Continue reading “Credit Risk Managers Must use Big Data in These Three Ways”
A valuation store, built up and kept up by charges against the bank’s working salary, is what we know by The Allowances for Loans and Lease Losses (ALLL). As an assessment measure, it is an evaluation of invalid sums that is utilized to decrease the book estimation of credits and rents to the sum that is relied upon to be gathered. The ALLL frames a piece of Capital of Tier-2; henceforth it is kept up to cover misfortunes that are plausible and admirable at the time of assessment. It does not work as a support against all conceivable future misfortunes; that assurance is given by the Capital of Tier 1. For building up and keeping up a satisfactory payment, a bank ought to:
Continue reading “Facts about Remittances for Credits and Rent Losses – Part 1”
In one of our previous blogs, we had initiated a discussion on the BASEL accords- a set of recommendations on banking regulations aimed at ensuring adequate capital for financial institutions such that they can absorb unexpected loss. Presently, we try to dig deeper into the different characteristics of the accords and their recommendations for capital adequacy.
As a regulatory capital requirement framework BASEL has evolved over time. The first set of Basel accords, BASEL-I created a risk insensitive minimum capital requirement. BASEL-II has been a huge development over its ancestor, as it had explicit emphasis on identifying different risk sources and allocating financial capital for each of them. BASEL-III is a more conservative version of BASEL-II. In this blog, we will focus on explaining minimum capital requirements prescribed in BASEL-II.
The minimum capital requirements are defined as the capital required, covering the three main areas of risk: Credit Risk, Operational Risk and Market Risk. Credit risk is the risk that arises from the default of making required payments on debt. Operational risk arises from failed internal processes (such as legal risk. Strategy and Reputation risk falls outside the purview). Market risk arises from losses on and off balance sheet position arising from movement in market prices. For the estimate of minimum capital requirements, the Risk-Weighted Assets must be calculated.
Why are Risk-Weighted Assets important in calculating minimum capital requirement?
Not all assets in a bank’s balance sheet are equally risky. For e.g. cash in an ATM is safer than a sub-prime mortgage. So regulatory capital must be set in relation to the riskiness of the asset rather than just by the value of the asset in the balance sheet. For Risk weighting asset, off-balance sheet as well as on-balance sheet items must be included. The idea is to prevent banks from creating tons of off-balance sheet assets and claiming there’s no risk at all. Off-balance sheet items include: financial instruments like forwards & future options, credit default swaps etc. Basel II prescribes the following risk weights across asset classes:
| Assets | Risk Weights |
| Cash and Equivalents | 0% |
| Residential Mortgages | 35% |
| Credit/ auto loans | 75% |
| Commercial Real Estate | 100% |
| Govt. Securities | By Rating |
| Interbank loans/Corporate Loans | By Rating |
| Other assets | 100% |
BASEL accords are a set of agreements set by the Basel Committee on Banking Supervision(BCBS) which provides recommendations on banking regulations in regard to credit risk, market risk and operational risk. The purpose of the accords is to ensure that the financial institutions have adequate capital on account to meet obligations and absorb unexpected loss. There are three versions of BASEL: BASEL-I, II and III. BASEL-I is relatively more simple compared to the later versions, in the sense that, its scope of definition of risk was limited only to credit risk. BASEL-II is a more advanced version of its predecessor in defining the scope and domain of banking risk. It points out three main areas of risks: Minimum Capital Requirements, Supervisory Review and market discipline. These are called the three pillars of BASEL. The focus of BASEL-II has been to strengthen the international banking requirements as well as to supervise and enforce these requirements. BASEL-III is the recent most version of the BASEL accords and most banks seeks compliance with it by the end of 2018. BASEL-III discusses the three pillars professed by BASEL-II in a more detailed manner by increasing the scope of the three pillars. In this blog we will discuss the three pillars of BASEL accords and the opportunities they generate in the analytics industry.
Pillar 1: Minimum Capital Requirements
BASEL-II emphasises that banks must have adequate capital to cover the three areas of risk exposure: Credit risk, Operational Risk and Market Risk. Credit risks are those which arise from the default on the loans made to obligors. The default occurs when obligors fail to make required payments. Operational Risk arises from failed internal processes. It includes legal risk, but excludes strategic and reputation risk. Market risks arise from losses on and off balance sheet position arising from movement in market prices. Statistical models are extensively used to develop predictive models for identifying the credit, operational and market risks. Probability of Default (PD), Loss given Default (LGD) and Exposure at Default (EAD) models are built to identify the inherent credit risk in the bank’s portfolio. Market risks are modelled using Value at Risk (VaR) and Economic Capital (ECAP) models. Building these models require a sound understanding of (i) the relevant business for which model development is done (ii) statistical techniques like Logistic Regression, Linear Regression, Time Series Analysis (both basic and advanced) (iii) segmentation techniques like CHAID, CART, Cluster analysis etc. and (iv) a very good understanding of soft wares like SAS, EXCEL and R.
Pillar 2: Supervisory Review
It provides with a framework to deal with risk related to systemic, pension, strategic, concentration, liquidity, legal and reputational. The accord combines all these risks under the title of residual risk. The aim of this pillar is to give better tools to the regulators. Black-Scholes-Merton of option pricing forms the basis of modeling for most of these risks (especially systemic risks). In order to develop this type of model you are required to have sound knowledge in terms of simulation Stochastic processes.
Pillar 3: Market Discipline
Market discipline supplements regulation as sharing of information facilitates assessment of the bank by others, including investors, analysts, customers, other banks, and rating agencies, which leads to good corporate governance. The aim of Pillar 3 is to allow market discipline to operate by requiring institutions to disclose details on the scope of application, capital, risk exposures, risk assessment processes, and the capital adequacy of the institution. It must be consistent with how the senior management, including the board, assess and manage the risks of the institution.
Banks require being compliant with all the three pillars of BASEL accords for prudently managing their risks. Hence Systematically Important Financial Institutions like Wells Fargo, HSBC, American Express, Bank of New York Mellon etc. look for resources with sound understanding of these pillars and the statistical knowledge required building models for their captive risk management process. Managing banking risk is perhaps the safest business to invest in as the extent of risks and regulatory compliance for banks are increasing overtime. Over the next few blogs we will try to understand the capital structures of banks and development of different BASEL compliant models for different pillars and capital tiers of banks.
Post the Financial Crisis of 2008, there has been an increase in the regulatory vigilance of the capital adequacy of commercial banks across the globe. Banks need to be compliant with different regulatory capital requirements, so that they can continue their operations under situations of stress. A majority of analytical work in Indian BFSI domain is to provide analytical support to US based multinational NBFC’s. We would like to throw some light on the opportunities and scope of credit risk analytics in the US banking and financial services industry. The Federal Reserve requires the banks to be compliant with three main regulatory requirements: BASEL- II, Dodd Frank Act Stress Testing (DFAST) and Comprehensive Capital Analysis and Review (CCAR).
Continue reading “Credit Risk Analytics and Regulatory Compliance – An Overview”