1. Basel II : Risk Model Validation Quiet Revolution in the Supervisory World State Bank of Pakistan KARACHI, March 12 th , 2007 Christian Marlier Senior Director Head of CRO Executive Office
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3. The higher the pressure put on trust The more important transparency and accountability become “ PROVE ME” “ TELL ME” “ TRUST ME” High Low Low High Basel I to Basel II TRUST TRANSPARENCY “ SHOW ME” From “Trust Me” to “ Prove & Evidence Me World”
4. BASEL II Impact on Authorities Training Capital Calculation Pillar I Validation Co-ordiantion of Information Planning & Co-ordination of Supervisory activities Coherency Between local accounting & tax framework Liquidity Spread Capital Strengthen soundness & stability of international banking system Promote Stronger Risk Mgt Practices Supervisors Consolidated / Home – Host Monetary Authority – Central Bank Minimum Required Capital Supervisory Review Market Discipline
5. Basel II impact on authorities Home & Foreign View Home State Bank Home Private Bank Foreign Private Bank Home Supervisor Mother Private Bank Validation Host / Home Host Supervisor Liquidity Spread Capital Monetary Authorities Central Bank Sovereign Ratings
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8. Role of Home and Host Supervisor Dialogue “Square Box” Consolidating Supervisor Mother Company Supervisory Cooperation Act as one company Bank’s Subsidiary Host Supervisor College of supervisors Local solvency reporting CRD local implementation Current legal requirements Consolidated Solvency Reporting Supervisory review Single entry point Validation & permission
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11. 1 2 4 3 5 6 7 8 Business Lines & CRO Needs Risk Model Basel II Validation Multiple Stakeholders Organisational Compliance Risk Analythics Business Lines Central Risk Management Risk Committees External Third Parties Internal & External Audit Supervisory Authorithies Basel II
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14. Create the development sample Choose the rating criteria (variables) Model Development PD calibration Model validation Risk Model Basel II Validation Technical Compliance
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16. Create the development sample Choose the rating criteria (variables) Model Development PD calibration Model validation Risk Model Basel II Validation Technical Compliance Definition of Default Basel II default Recovery default Timeline Back to non- default level Risk class End-of- year Timeline Performing loans Pass Special Mention Uncertain Doubtful
17. Create the development sample Choose the rating criteria (variables) Model Development PD calibration Model validation Risk Model Basel II Validation Technical Compliance Definition of Default Transitions from Recovery level to the the Basel II level
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20. Model power measures Model integrity Validation samples Validation over time Create the development sample Rating criteria (variables) Model Development PD calibration Model validation Risk Model Basel II Validation Technical Compliance Does the model rank order? Has the model used sensible characteristics? Has an appropriate model methodology been used? Has validation down to characteristic analysis been undertaken – e.g. marginal chi-squared analysis ? Has it been tested on different good / bad definitions? Has it subsequently been used in practice by the bank?
21. Model power measures Model integrity Validation samples Validation over time Create the development sample Rating criteria (variables) Model Development PD calibration Model validation Risk Model Basel II Validation Technical Compliance 115 files 20 Rating Anomaly Managers (Ram) C orrelation : 80 % with range 65 % and 95 % depending on Ram’s Commercial Loss : error Type II Financial Loss: error Type I
22. Model power measures Model integrity Validation samples Validation over time Create the development sample Rating criteria (variables) Model Development PD calibration Model validation Risk Model Basel II Validation Technical Compliance
23. Model power measures Model integrity Validation samples Validation over time Create the development sample Rating criteria (variables) Model Development PD calibration Model validation Risk Model Basel II Validation Technical Compliance 0% 2% 4% 6% 8% 10% 12% 14% 17 16 15 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0% 2% 4% 6% 8% 10% 12% 14% frequency model % 'defaults' Masterscale Mapping
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26. Credit Limit Credit Process Pricing & Performance Market Risk Monitoring Key uses Risk Model Basel II Validation Implemantation Compliance Revenues : Customer Pricing & Performance Analysis Operational Risk Profile Risk Awareness Number of losses Average loss Year 1 Year 2 Year 3 Banking 3 Banking 2 Banking 4 Banking 1 Banking 5 750 MM 500 MM 0 AAA AA A BBB BB B CCC CC C Nominal Amount Theoretical Risk Curve Implemented Delegation Power Credit Delegation Power Market Risk