133_2006ws_tomasvaclavik

8/13/2019 133_2006ws_tomasvaclavik

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Validation of Basel II Models

Tom VclavkIES FSV UK

CNBBanking Regulation and Supervision Department


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Presentation Structure

1. Basel II Basics reminder

2. Core Structure of Validation

3. Problems Connected to Validation

4. Conclusion


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History of Basel

Basel Iduring 90s became insufficient banks learned how to trick the old standards

big expansion in IS/IT

development in markets and instruments

Basel II2004 first official release first starts from late 90s- form of CP (consultant papers)

dynamically developping until now Basel II is not the final stopwhat comes next?


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Basel II Structure

Pillar 1 - Minimum Capital RequirementsCredit Risk (Standardized Approach, IRBApproachesFoundation and Advanced)

Operational Risk (Basic Indicator Approach, Standardized Approach (similar),Advanced Measurement Approaches (AMA))

Market Risk(Stardardized measurement approach, In-House model approach; VAR)

Pillar 2 - Supervisory ReviewKey principles of supervisory review

Risk management guidance

Supervisory transparency and accountability

Pillar 3 - Market DisciplineMotivates management to transparency public reporting etc.


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Validation Core Structure

1) Problem identification- will to participate, agreements with regulator

2) Prevalidation- for both bank and regulator necessary step

3) Validation- 6 months to validate/refuse model

4) Use- controls of usage


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Problem Identification

Advanced models in Basel II are optional

Bank must consider cost/benefits of

building and using new model

Making of structure + Analysis of data

needed/accesible

Communication with regulator(s) make some outline with regulators in all countries

Start of process


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Prevalidation

Basel II allows different interpretation

Regulatory organs has only 6 months forvalidation in this first stage is impossible to validate models for 6 or10 banks at the same time in 6 months

Cooperation between banks and supervisorsbefore validation

- communication profitable for both sides

-regulator has more time

-banks have more interactive response and freeconsultative partner

- both can convince other side to change view on uncleartopics

- whole Basel II implementation is about AGREEMENT


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Validation

Usually follows after months of prevalidation

6 moths after banks official requestFORHOME SUPERVISOR

Usually most things readymainly

administration and last checks without changesof model

- model should be tested at least one year before end ofvalidation (sometimes some changes in running model)

Communiaciton between central banks,compliance tests, synchronization,

Official statement for bank: Yes/No


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Control of model adjustment

Both On-site and Off-site supervisions

Yearly - Backtesting

Are models working properly?Use tests

Does bank follow up necessary data inputrequirements?

Interactivity of model implementations

New, comes 1.1.2007 (IRBA, AMA2008)


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Problems connected to

Validation Home-host regulatory problems

- harmonization for the whole group

Wide frontiers of models

models are not given strictly, only ways and borders

Basel II needs explanation

lot of topics are not clear, banks demand regulatory

organs to clarify Data

- quality of data, amount, short history, expensiveness


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EU banking regulation and

supervision CRD (Capital Requirements Directive) which translates

Basel II into EU law ratified in October 2005

National responsibility for banking supervision supervision is task of national supervisory authorities

different national supervisory systems

EU directives: Harmonisation of certain standards &mutual recognition Consolidated supervision of cross-border banking groups

EU Passport: single licence + home country control

EEA co-operation and co-ordination (for no EU countries?) Europian Economic Area = EU+ Nor., Isl., Lich.

cross-EEA (multi-lateral committees)


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Home-Host Supervision

Basel II brings inovationonly one approvalneeded for consolidated group in the country ofParent bank (home country)=> HOME SUPERVISOR

Countries of Subsidiary banksHost

Supervisorscan influence only standalonebase (local level)(can force bank to count for host country different model from model forhome countryf.e. Czech bank must in Czech count retail models withFoundationIRB and consolidated bank group counts with AIRB)

- approves home models or demands specific changes- usually influences only retail and corporate models

The point is to make everything working, Basel IIcounts on agreements among all participants


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Models Frontiers

Only core restrictions

Ways to calculate PD, LGD, VaR etc. can not be

strictly givenbanks develop models and ask

for approval Main responsibility is given to supervisor

- enoromous consequences of bad decisionsup. must strictly

follow directive and check if all paragraphs are fulfilled

- sometimes partial excuses - time restricted (for 1y etc.)

Compulsory directives are not very specific, is it

good or badfor which side?


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Basel II needs explanation

Many topics are not cleardifferent groupshave different interpretation of Basel II

CP10: intention to write explanatory document

(guidelines) Authors of B.II did not write any document aboutwhat they ment by some requirements

Not enough time to gain more experiences and

clarify remaining problems Are Basel II standards really good? Or is the

timing really right?


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Troubles with Data

Not enough time for banks to collect data(excuses for the first years of B.II implementation, 5y (ormore) data series since 2010 needed, now 2y enough)

Not enough data (f.e. Defaults of municipalities)

Discussable quality of data- different collecting methods (+ quality of these meth.)

- various clients and databases in one bank

- usually no possibility to check relevance of data Expensiveness banks guard also overall and

anonymous data, models (no chance to use them for papers etc.),no exchange, no sale - makes evereything more difficult


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Conclusion

Validation is relatively new topic

Learning of new experiences

Full impacts will show in near (or far)future

What comes next?

133_2006ws_tomasvaclavik

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