Quantification of Credit Risk

(Croatian perspective) Quantification of Credit Risk

(Croatian perspective)

Stjepan Anić, Dejan DonevErste & Steiermärkische Bank d.d.

Stjepan Anić, Dejan DonevErste & Steiermärkische Bank d.d.

ToCToC

1. Components of Credit risk1. Components of Credit risk

2. Quantification - You can manage what you can measure2. Quantification - You can manage what you can measure

3. First thing’s first - Scoring & Rating Models3. First thing’s first - Scoring & Rating Models

4. Tasks of a modern risk manager4. Tasks of a modern risk manager

5. Required Competences5. Required Competences

Risk ComponentsRisk Components

Risk

(two components)

ExposureUncertainty

Market RiskCredit Risk Operational Risk

Regulatory acknowledged types of risk

Uncertainty

Default risk Recovery risk

Exposure

You can manage what you can measureYou can manage what you can measure

Credit Risk

Uncertainty

Default risk Recovery risk

Exposure

PDi = f i (Rating grade)

i = 1, ... , n

( n number of exposure classes )

LGD k,j= f ( k, j )

k = 1, ... , p; j=1, ... , q

( p no. of collateral types

q no. of types of facilities)

EaD = f ( i , j )

l = 1, ... , r

( r no. of clients )

Scoring & Rating ModelsScoring & Rating Models

• Credit quality of a client is analyzed, modeled and ranked

• Credit Scoring Transformation of input variables describing banks’ client in numbers, sum of which (credit score) gives numeric estimate of his credit quality– Privates socio-demographic data– Corporates financial ratios

• Credit Rating grouping of score bins (plus some other things)

• Predictive aspect of score/rating forecast default tendency of a client within the one year horizon (PD scoring/rating)

CR spectrum

INput variables

Rating migration

Problem with dataProblem with dataWARNING ! Experience shows that many problems emerge from unsatisfactory quality and

availability of data Models are as good and accurate as are the data on which they are developed Time needed for preparation of raw data for the purposes of modeling is usually

dramatically underestimated (during the phase of project planning)

Scoring Model developmentScoring Model development

Defaulted

Loan applications

/Annual

financial statements

Not defaulted

Binomial

event

t t+12 m

MethodologyMethodology

Data mining Techniques used to find patterns and relations within the data Proper usage of DM techniques for model building requires knowledge

about business problem we’re trying to solve

Data Mining

Data-bases Statistics

VisualisationIT technology

Machine learning

Tasks of a modern risk managerTasks of a modern risk manager IDENTIFICATION OF RISK RELEVANT INFORMATION

creating a list of necessary RM measures and procedures for all types of products and clients

PROPER RECORDING OF IDENTIFIED INFORMATION Centralized Risk DWH Data–collection in hands of people which understand the data and their usage

CALCULATION OF RISK PARAMETERS transformation of recorded info into prediction of possible losses (construction of a probability of loss distribution)

INTERPRETATION AND USAGE OF RESULTS RM must insure that resulting risk parameters (PD, EL, CapReq, etc.) are used throughout the bank in a consistent manner (loan decisioning, portfolio mngmt, planning, provisioning, pricing, etc.)

Loss Dist

RiskCapital

Required CompetencesRequired Competences TECHNICAL EXPERTISE IT competences (knowing how to retrieve

data from data-bases, SQL, basic programming skills - VBA)

METHODOLOGICAL EXPERTISE skills in quantitative analytical modeling (mathematical and statistical modeling, econometrics) and skills in predictive data-mining (SAS, MATLAB, SPSS, etc.)

BUSINESS EXPERTISE knowing the business (banking & finance, risk management, CRM, etc.)

ANALYTICAL (AND ABSTRACT THINKING) MINDSET can transform business problems into abstract terms and solve them like mathematical problems in algorithmic form

MODERN RM ENVIRONMENT = CROSS-FUNCTIONAL TEAMS

Four major competencesFour major competences

AnalyticalAnalyticalexpertiseexpertise Technical Technical

expertiseexpertise

MethodologicalMethodologicalexpertiseexpertiseBusinessBusiness

expertiseexpertise

All All fourfour planets in this Risk planets in this Risk Orbit have to function Orbit have to function perfectly, otherwise perfectly, otherwise we we could be facingcould be facing......consequences consequences of truly cosmic of truly cosmic proportions !proportions !

Thank you for your attention!Thank you for your attention!Thank you for your attention!Thank you for your attention!