Page 3
BIS Regulatory Model Vs Credit Risk Models
Disadvantages of BIS Regulatory Model
1. Does not capture credit-quality differences among private-sector borrowers
BIS model requires 8% of total.
8% Bank of Thailand8%
Correlation = 0.15
Risk Management Symposium September 2000
Actual exposure is only 6% of total.
Page 6
Overview
❖ BIS regulatory model Vs Credit risk models
❖ Current Issues in Credit Risk Modelling
❖ Brief introduction to credit risk models
Purpose of a credit risk model
Credit Rating Probability of Default
AAA
0.00%
AA
0.00%
A
0.06%
Credit Rating Probability of Default
BBB
0.18%
BB
1.06%
B
5.20%
CCC
19.79%
Note: 1. Probability of default is based on 1-year horizon.
2. Historical statistics from Standard & Poor’s CreditWeek April 15, 1996.
Bank of Thailand
Risk Management Symposium -
Page 5
September 2000
BIS Regulatory Model Vs Credit Risk Models
Default correlations can have significant
impact on portfolio potential loss. KMV finds
that correlations typically lie in the range 0.002
to 0.15.
8%
8%
Correlation = 1
Note: Some adjustments are made to collateralized/guaranteed loans to OECD governments, banks, and securities dealers.
Bank of Thailand
Risk Management Symposium September 2000
BIS Regulatory Model Vs Credit Risk Models
BIS Risk-Based Capital Requirements
All private-sector loans (uncollateralized) are subjected to an 8 percent capital reserve requirement, irrespective of the size of the loan, its maturity, and the credit quality of the borrowing counterparty.
Risk Management Symposium September 2000
Page 4
BIS Regulatory Model Vs Credit Risk Models
Big difference in probability of default exists across different crediory Model Vs Credit Risk Models
Credit Risk Models
- Credit Risk+ - Credit Metrics - KMV - Other similar models
Bank of Thailand
Risk Management Symposium September 2000
2. Ignores the potential for credit risk reduction via loan diversification
These potentially result in too large a capital
requirement!!!!!
Bank of Thailand
Risk Management Symposium -
September 2000
Page 7
Current Issues in Credit Risk Modelling
Common components
Model from insurance (Credit Risk+)
Credit Metrics
KMV
❖ Model comparison
Bank of Thailand
Risk Management Symposium September 2000
Page 1
Unexpected loss
8%
Assumption: All loans are of equal size, and correlations between different counterparties are 0.15.
3.54%
1
Bank of Thailand
16
# of counterparties
BIS Regulatory Model Vs Credit Risk Models
The capital requirement to cover unexpected loss decreases rapidly as the number of counterparties becomes larger.