Credit risk monitoring systems
In the new Basel 2 accord, in the validation activity the company must continuously control the reliability of the rating system results and the maintenance of their adherence to the prescribed regulations, company operative requirements and the evolution of the relevant market.
Our activity consists in analysis covering the areas listed above:
- rating system performance
- parameter alignment
- stress tests.
The validation aspects which relate to the monitoring system are the following:
- the constant estimate sample representativeness in relation to the respective population;
- the performance of credit pool rating and attribution assignment quantitative models in terms of accuracy, predictive power, the ability to order the borrower on the basis of risk, single portfolios and appropriate breakdowns of these portfolios on the basis of various classification criteria (e.g. type of company, geographical location, product type, % deposit, etc.);
- the accuracy of risk parameter estimates compared to the empirical evidence after the estimate (back-testing);
- the dynamic properties of the rating system, in terms of stability and migration rates;
- the appropriateness of the stress-test procedures.
Bearing in mind the regulatory requirements, the objectives of a monitoring system are the following:
- monitor the rating system performance to demonstrate the validity over time and prevent obsolescence, guarantee the Supervisory Board that validation standards have been adhered to and supply administrative and company control bodies with the tools to check the system;
- measure accuracy and stability of the estimates using appropriate statistical mechanisms and reporting;
- supply inputs for estimate modelling system updates/revisions interventions, if required (e.g. regressor variation, etc.);
- quantify the impact on employed expected losses and regulatory capital by “extreme” variations of portfolio risk and extraordinary operations (e.g. transferred credit and securitisation).
To achieve the aims as above, the monitoring system that we implement consists of three distinct functional modules:
- Estimate Accuracy Module (back-testing)
- Estimate Stability Module
- Simulation Module (stress-testing).