Managing Risks in Financial Services: Case Study

Credit Risk – Internal credit risk rating system definition and setup for a major retail bank

The Issue

The Basel II Advanced Internal Rating-Based approach requests that all credit risk components (Probability of Default (PD), Loss Given Default (LGD), Exposure at Default (EAD) and Maturity (M)) have to be internally estimated by the banks.

In this context, a major retail bank asked for PricewaterhouseCoopers' assistance to perform different challenges such as:

• Assessing project feasibility and identifying data required for the internal system;
• Analysing the Basel II constraints (minimum requirements in the A-IRB approach);
• Developing and implementing an internal rating system based on a statistical approach, providing an assessment of the Probability of Default (PD).

Our Approach

The first step consisted in analyzing the feasibility of the project, taking into account:

• The data quality sources, their availabilities and documentation;
• The internal resources availability;
• The default definition and the number of clients in default.

The second step consisted in checking the delivered data quality and defining the risk driver computation. To do so, we undertook the following actions:

• Design and implementation of a database allowing to work in groupware mode and centralise data documentation;
• Set-up of a quality control procedure;
• Development of SAS programs to automate parts of the control procedures.

The third and final step enabled the estimation and validation of the scoring models thanks to the SAS program.

The Outcome

The successful implementation of the internal rating model enabled the bank not only to become Basel II compliant but also to:

• Improve significantly its credit risk management framework
• Reduce its regulatory capital requirements
• Meet the financial market players' expectations