Skip to content

Credit Risk

The dedicated space to converse with peers and our experts on all aspects of credit risk, from the technicalities of modelling using internal approaches, credit decisioning and underwriting, credit risk appetite, governance and monitoring, provisioning, and regulatory requirements

27 Topics 75 Posts
Contact Oliver Wyman

Reach out to our team if you want to collaborate on recent developments in Risk.

Subcategories


  • Our dedicated space to discuss practicalities and technicalities of credit risk modelling using internal modelling approaches

    5 Topics
    14 Posts
    U

    In recent years, UK banks have increasingly found themselves allocating a significant portion of their risk budgets to Internal Ratings-Based (IRB) remediation programmes. This trend underscores a pervasive underestimation of the challenges involved in building and operating effective IRB models. As we look ahead, it is clear that a more effective approach is not only possible but essential for navigating the upcoming waves of regulatory scrutiny and operational demands

    Our experience - as well as regulatory feedback - shows that robust governance and senior ownership is important, reflected in committee membership and a culture of review and challenge of key judgments

    One critical issue is the composition of the teams tasked with model development. While these teams often possess substantial IRB expertise, they frequently lack robust coding skills. Although banks have established enablement and engineering teams to bridge this gap, the collaboration between these groups is often not fully functional. As a result, much of the code remains monolithic and SAS-based, which complicates quick implementation and increases the likelihood of errors. This disconnect highlights the need for a more integrated approach that combines modelling acumen with technical proficiency to enhance the efficiency and accuracy of IRB model development

    To address these pain points effectively, we recommend three key strategies. First, creating mixed teams of modellers and experienced coders can significantly enhance the development process. By integrating technical expertise with modelling knowledge, banks can improve workflow efficiencies. This collaborative approach not only streamlines the development timeline but also ensures that the initial code is closer to a deployable state. We have also found firms benefit from code sharing through platforms like GitHub, and establishing rigorous code review processes. Code libraries and ‘scaffolding’ (re-usable code structures) also make model development more controlled, repeatable and efficient.

    Second, when using external support, implementing risk-sharing arrangements for delivery can lead to more successful and cost-effective outcomes. By fixing delivery costs while also aligning incentives for successful model results, banks can attract the right level of seniority and mix of resources necessary for effective model development. This shift in focus can help mitigate the risks associated with failed deliveries, ultimately leading to better resource allocation

    Lastly, fostering greater involvement of internal stakeholders throughout the model development phase is crucial. By explicitly engaging these stakeholders and focusing on their understanding of risk management practices and the operational environment, banks can ensure that modelled approaches are more closely aligned with business needs. Additionally, enhancing the education of business units about IRB processes can facilitate stronger collaboration and reduce tensions between modelling teams and business units, ultimately improving the overall effectiveness of IRB models

    In conclusion, while the journey towards effective IRB remediation is challenging, there is a clear path forward. By addressing the pain points head-on and adopting a more integrated and collaborative approach, UK banks can not only ease the current IRB pain but also develop sustainable modelling capabilities going forward. If you would like to get more information on how we organise our teams in our risk-sharing agreements on IRB delivery, feel free to reach out

    This post was authored by Cem Dedeaga, a partner in our Finance and Risk Practice, based in the London office, specialising in prudential credit risk topics. With extensive experience across a diverse range of financial institutions, Cem leads large-scale prudential credit analytics delivery (IRB, IFRS 9) in the UK and Europe. His expertise encompasses the delivery of comprehensive credit risk models and frameworks, helping banks improve compliance with regulatory standards

  • Credit Risk Modelling Survey

    Pinned
    1
    0 Votes
    1 Posts
    19 Views
    No one has replied
  • Use test requirement benchmarking survey

    4
    0 Votes
    4 Posts
    11 Views
    U

    If you have any questions or comments please reply to this thread!

  • 0 Votes
    6 Posts
    33 Views
    U

    @OP

    In which case,

    No change in default level – new Soft UTP is not adding any defaults (there must be fully correlated to any existing trigger or triggers e.g. 90DPD, bankruptcy, etc.)

    No timing difference of default event – therefore no PD or LGD impact even due to discounting

    Client has only limited historic time series to show proof

    Both 1 and 2 indicate there is full correlation to already existing triggers at the existing time period (but level of correlation can differ at time (t) for each trigger toward the new Soft UTP trigger).

    Based on the other responses to this question, a bootstrapping would be the correct approach, but the bank states on recent periods the outcome should be NULL (or similar like that)

    Therefore, an idea could be to simulate the uncertainty of the correlation in different macroeconomic environments

    Correlation analysis of macro economic factor vs existing triggers over time (t) Given that new Soft UTP trigger is correlated toward multiple triggers at time (t) (based on existing time period the bank has), the correlation variation found of each underlying existing trigger can be used to proxy new Soft UTP trigger back in time

    PLUS above should still be supplemented with a qualitative statement

  • 0 Votes
    1 Posts
    7 Views
    No one has replied
  • Materiality for revolving exposures in Definition of Default

    1
    0 Votes
    1 Posts
    5 Views
    No one has replied
  • IRB approval level (Group vs Country)

    5
    0 Votes
    5 Posts
    10 Views
    U

    We’ve seen a variant of this issue in US/Canada, with the large Canadian Banks generally having IRB approval at the Group level (including for their main US loan books) and their US subsidiaries being on standardized

    In this case, there is no incentive for the US entity to seek IRB approval - but US regulators do care about the risk rating systems from a bank supervision perspective, which has raised some of the same questions about whether group models are suitable. Those banks have generally taken a view aligned to a previous poster, i.e., using local models for middle market and below, and trying to align to group models for larger companies and FI's

    On the last point, I'll say that we've seen US regulators challenge the support for those decisions heavily, but at least in some cases it seems to have stood up to that challenge.  In one case where the bank's prior analysis and documentation didn't provide great support, they are being pushed to redevelop those as well, though they are trying to do so in a way that they can ultimately extend back to group as well, for a C&I model that was getting a bit long in the tooth anyway

  • 0 Votes
    3 Posts
    5 Views
    U

    I'll just flag that a Canadian bank who had decided to extend several of their existing "global" models to their US subsidiary based on similar logic, and while the logic makes sense broadly, they ran into significant issues with their US subsidiary’s regulator about the way they did it

    I would primarily attribute the root causes of those issues to:

    Operating model for how those decisions were taken and where they were reviewed and challenged – the Group development and validation teams led the substantive assessment of “fit-for-use”, and while there were some US stakeholders involved, the ones most involved were not very senior in stature, and often deferred to the expertise of Group.  But those US stakeholders then couldn’t / didn’t do a good job of credibly defending those decisions to their regulators, leading the regulators to question if US senior management had been sufficiently involved in determining that these models were appropriate for the US portfolio

    The documentation they produced justifying and validating the use of these models in the US was a narrow “fit for use assessment”, which taken as a standalone artifact fell far short of the comprehensive model documentation and validation expectations of SR 11-7.  This led regulators to question the “effective challenge” provided by US model risk management and more broadly by US senior management

  • Benchmarks for predictive power of retail underwriting models

    4
    0 Votes
    4 Posts
    31 Views
    U

    Thanks a lot, this was very helpful!

  • 0 Votes
    2 Posts
    12 Views
    J

    Very interesting point. Would be great to know OW's experience with feedback from other players.

  • Effective maturity for FIRB

    2
    0 Votes
    2 Posts
    5 Views
    U

    I suspect the answer will depend on what regulators require – for example the PRA expects all FIRB firms to use effective maturity (there’s currently a carve-out for SMEs, but they want to remove that too under Basel 3.1 – see below)

    I have to admit, I cannot recollect what ECB/ EBA has had to say about this, but I think it would be pretty hard to justify using it in most places but not some – would very much feel like a bank would be open to challenge around whether it was cherry-picking

    PRA CP16/22 proposal around Effective Maturity

    4.305 The PRA currently specifies within IRB permissions that firms using the
    FIRB approach must calculate effective maturity rather than apply fixed
    parameters. This is because the PRA considers that calculation of effective
    maturity is a more risk-sensitive approach, which better reflects the economic
    substance of the exposures, and thus enhances the safety and soundness of firms.
    Furthermore, using effective maturity facilitates effective competition because
    firms using the AIRB approach are also required to apply the effective maturity
    approach.

    4.306 The PRA proposes to maintain the substance of its existing approach and
    that firms using  the FIRB approach would continue to be required to apply the
    effective maturity approach. The PRA proposes to include this provision in its
    rules as it considers this would be more appropriate than applying the
    requirement on a firm-by-firm basis as is currently the case.

    4.307 The PRA considers that the proposed approach is in line with the Basel 3.1
    standards as these include a discretion for national supervisors to require
    firms using the FIRB approach to calculate effective maturity for all exposures.

    4.308 Similarly, to improve risk-sensitivity, the PRA proposes to remove the
    option currently setout in the CRR that allows firms that are otherwise
    calculating maturity to instead apply fixed maturity values for exposures to
    small UK corporates.

  • IFRS9 - LGD Models

    1
    0 Votes
    1 Posts
    7 Views
    No one has replied
  • How long for a portfolio to be eligible for IRB?

    1
    0 Votes
    1 Posts
    9 Views
    No one has replied
  • Risk Rating Model Overrides: Supporting evidence

    1
    0 Votes
    1 Posts
    3 Views
    No one has replied
  • Internal Risk Rating Development Questions

    7
    0 Votes
    7 Posts
    7 Views
    U

    The other C&I related criteria I have seen for segmentation (may or may not be captured by your size / sector view):

    Rated / quoted vs. not (on the basis these firms have access to additional sources of funding plus an extra source of predictive info, although that can be reflected by other mechanisms) Specialised lending vs not (Basel has some rules re: when should be viewed as specialised – to some extent it comes down to legal form) Legal form e.g. limited liability vs. partnership vs sole trader (at bottom end) Leverage finance / recent transaction e.g. divestiture, M&A … (on the basis that they are more sensitive to changes and historical performance data may be less relevant
  • IRB - Migration Matrix

    3
    0 Votes
    3 Posts
    6 Views
    U

    Might also be worth taking a look at the detail in sections 2.5.5.1 - 2.5.5.2 dealing with customer migrations and migration matrix stability respectively, in the ECB's Instructions for reporting the validation results of internal models, pgs. 23 - 24

  • Wholesale Credit Risk PD Model

    2
    0 Votes
    2 Posts
    6 Views
    U

    A number of UK banks have their wholesale PD models produce both “TTC” and “PIT” ratings – with the latter typically being driven by some sort of adjustment based on Moody’s KMV EDF’s or equivalents – you also have a number of other banks that for IFRS 9 will apply macro-economic model outputs on top of a largely TTC rating model to produce a PIT PD for IFRS 9 provisioning/ allowances purposes. The dual rating approach at big UK banks was heavily driven by a couple of modellers by the names of Scott Aguais and Lawrence Forest, and they have published a few papers describing their approach.

    On the question of splitting by “investment Grade” vs “non-investment grade”, I’ve never seen this, although a split between leveraged and non-leveraged is common historically (when we built the model for one of the large German banks, we were able to reintegrate them). But size r whether a customer is rated/ quoted/ listed is a common basis for segmentation in the commercial space.

    For EU banks, qualitative questions still tend to be included, although people are working to make them objective where possible, but not sure many have entirely removed them (again Scott Aguais was wanting to do this for one of the big UK banks – not sure whether he succeeded) – the issue with qualitatives is whether you can find the sweet-spot – at bottom end SME, often I don’t think credit officers have any real insights into their customers given how many they cover; at top-end, question is whether the credit officer has real insight beyond what can be captured by tools such as Factiva Sentiment Signals

    Historically, it has been difficult to remove size segmentation from the entire corporate customer base, in part because you tend to see some factors have different relationships for small vs large firms (e.g. you might want a fair bit of cash on balance sheet of an SME, but for a large firm, this would be inefficient and you’d perhaps worry if management wasn’t trying to make their cash work hard )

  • Are aeroplanes just ships of the sky?

    8
    0 Votes
    8 Posts
    13 Views
    U

    Airplanes are ships of the sky from an LGD perspective, but not from a PD perspective. Railcars are also ships of the land by the same token

    From a PD perspective, they are generally separate. The maritime companies and airlines have very different obligor dynamics

    From an LGD perspective, the main drivers are downtime (i.e. how long the asset sits idle after a default) and shortfall (i.e. the decrease in the new lease after a default since usually periods of default coincides with pressure on asset prices and lease rates), but not the value on the plane. It is seldom that you’d actually lose the asset in any meaningful way, so that does not affect the LGD. There are international treaties that lessors would seek the jurisdiction of the lessee be a part of, before sending an expensive plane over with a long lifetime left on the asset. The other jurisdictions get the older planes where the lessor does not care all that much, whether they get it back or not

    To be clear, you’d parameterize the LGD model differently for different assets as the downtime and shortfall dynamics are different. But the model structure is the same. So, it becomes a bit of an optical choice on whether you call that a single model or not

  • Credit risk rating models for FIs - use of structural models

    3
    0 Votes
    3 Posts
    4 Views
    U

    This may just be a rumour and so worth trying to Google to verify it, but I recall a long time ago that the MKMV model didn’t work well for banks, this was a known shortcoming of the model

    It’s not at all clear what other type of structural model (other than something like KMV) one could even attempt for a bank…

  • Using external model for PD modelling?

    1
    0 Votes
    1 Posts
    17 Views
    No one has replied
  • Inclusion of COVID period for credit modelling

    1
    1 Votes
    1 Posts
    15 Views
    No one has replied
Terms of Use Privacy Notice Cookie Notice Manage Cookies