The World Bank
SuperintendenciaBancaria
Banco de la Republica Colombia
Asobancaria
Building a Technology Framework to Meet the Basel II Requirements
Risk Management Workshop COLOMBIA :From Theory to Implementation
Cartagena, ColombiaFebruary 16, 2004
Presented byDavid M. Rowe, Ph.D.
Executive Vice President for Risk ManagementSunGard Trading and Risk Systems
Agenda
1. Introduction – A Brief History of the Basel Accord
2. Data Issues and Technology Challenges
3. Support for Broader Trends in Risk Management
4. Solution Components to Manage Credit Risk Under Basel II
5. Importance of Communication
Basel Capital Accord – Brief History
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1935 1945 1955 1965 1975 1985 1995
Tota
l E
qu
ity
Cap
ital
to
To
tal A
sset
sU.S. Bank Capital Ratios – 1935 - 1988
Depression thru WWII
Post-War Recovery thru early 1960s
Mid-60s thru Mid-70’s
Mid-70s thru Late-80’s
Basel Capital Accord – Brief History
Basel I
1986 – Proposed minimum regulatory capital requirements for banks.
1988 – Capital requirements came into effect with minimum capital rising to 8% of risk adjusted assets by the end of 1992.
The capital calculation was intended to distinguish among assets by risk class, but did so in only the crudest fashion.
Overview of risk weights
The Basel I Approach
Claim
Sovereigns
Assessment
Corporates
Comm. Banks
OECD Non-OECD
0% 100%
20%
20%
100%
100%
OECD Non-OECD All
50%
Multi-National Development Banks
All
Secured ResidentialMortgages
Required data could largely be derived from financial reporting systems.
Basel Capital Accord – Brief History
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1935 1945 1955 1965 1975 1985 1995
Tota
l E
qu
ity
Cap
ital
to
To
tal A
sset
sBank Capital Ratios – 1935 - 1988
Depression thru WWII
Post-War Recovery thru early 1960s
Mid-60s thru Mid-70’s
Mid-70s thru Late-80’s
Basel Capital Accord – Brief History
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
1935 1945 1955 1965 1975 1985 1995
Tota
l E
qu
ity
Cap
ital
to
To
tal A
sset
sBank Capital Ratios – 1935 - 1998
Depression thru WWII
Post-War Recovery thru early 1960s
Mid-60s thru Mid-70’s
Mid-70s thru Late-80’s
Late-80s forward
Basel Capital Accord – Brief History
Basel 1.5
Proposed: 1993Effective: 1998
CreditRisk
+
MarketRisk
Basel 1
Proposed: 1986Effective: 1988
CreditRisk
Basel Capital Accord – Brief History
April, 1993 – Initial “prescriptive” proposal.
April, 1995 – Proposed allowing use of internal market risk models for calculation of regulatory capital (subject to supervisory review and approval.)
Jan 1, 1998 - Market risk amendment took effect with internal VaR models as a major source of risk estimates.
Basel I
Market Risk Amendment
Basel Capital Accord – Brief History
Basel 1.5
Proposed: 1993Effective: 1998
CreditRisk
+
MarketRisk
Basel 1
Proposed: 1986Effective: 1988
CreditRisk
Basel 2
Proposed: 1999Effective: 2007
CreditRisk
(Enhanced)
+
MarketRisk
(No change)
+
Op Risk(New)
Key sources of required work for affected banks.
Agenda
1. Introduction – A Brief History of the Basel Accord
2. Data Issues and Technology Challenges
3. Support for Broader Trends in Risk Management
4. Solution Components to Manage Credit Risk Under Basel II
5. Importance of Communication
By Country US JP AU JPBy Industry Finan Steel Chem
By Corporate Family Alpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
Internal Region ProductLoans
EMEA Trade CreditDerivative TradingLoans
Asia Trade CreditDerivative TradingLoans
Americas Trade CreditDerivative Trading
Data Fragmentation
System Integration tends to be along internal regions and products.
By Country US JP AU JPBy Industry Finan Steel Chem
By Corporate Family Alpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
Internal Region ProductLoans
EMEA Trade CreditDerivative TradingLoans
Asia Trade CreditDerivative TradingLoans
Americas Trade CreditDerivative Trading
Data Fragmentation Credit Risk data requirements cut directly across
existing system fragmentation.
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
By Country US JP AU JPBy Industry Finan Steel Chem
By Corporate Family Alpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
Internal Region ProductLoans
EMEA Trade CreditDerivative TradingLoans
Asia Trade CreditDerivative TradingLoans
Americas Trade CreditDerivative Trading
Data Fragmentation Credit Risk data requirements cut directly across
existing system fragmentation.
Alpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
By Country US JP AU JPBy Industry Finan Steel Chem
By Corporate Family Alpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
Internal Region ProductLoans
EMEA Trade CreditDerivative TradingLoans
Asia Trade CreditDerivative TradingLoans
Americas Trade CreditDerivative Trading
Data Fragmentation Credit Risk data requirements cut directly across
existing system fragmentation.
Finan Steel ChemAlpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
By Country US JP AU JPBy Industry Finan Steel Chem
By Corporate Family Alpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
Internal Region ProductLoans
EMEA Trade CreditDerivative TradingLoans
Asia Trade CreditDerivative TradingLoans
Americas Trade CreditDerivative Trading
Data Fragmentation Credit Risk data requirements cut directly across
existing system fragmentation.
US JP AU JPFinan Steel ChemAlpha Beta Gamma
Alp
ha
Ba
nk (U
S)
Alp
ha
Se
curitie
s Inc. (Ja
pa
n)
Be
ta S
tee
l Co
rp. (Ja
pa
n)
Be
ta C
he
mica
l Ltd
. (Au
stralia
)
Ga
mm
a C
he
mica
ls (Jap
an
)
Overview of risk weights
Credit Risk - Standardised Approach
Claim
Sovereigns
Assessment
Option 1
Option 2
Corporates
Banks
AAA to AA-
A+ to A-BBB+
to BBB-BB+ to B- Below B- Unrated
0% 20% 50% 100% 150% 100%
20%
20%
20%
50%50%
50% 100%
100%50%
100%
100%
150%
150%
150%
100%
100%
50%
AAA to AA-
A+ to A-BBB+to BB-
Below BB- Unrated
Required data must come from risk systems.
Credit Risk - IRB Approach
Regulatory capital = EAD x risk weight (f [PD, LGD, M]) x 8%
This implies an even greater need for data from risk systems rather than just financial systems.
Regulatory capital = EAD x risk weight (f [PD, LGD, M]) x 8%
Estimation of Probability of Default (PD) FoundatioFoundation n IRBIRB
Estimation of Exposure at Default (EAD)
Estimation of Loss given Default (LGD)Advanced Advanced IRBIRB
Regulatory capital = EAD x risk weight (f [PD, LGD, M]) x 8%
The First Challenge: Data Integration
Consolidating exposure across products, regions and systems (by obligor or by risk characteristics.)
Maintaining clean and consistent legal entity and facilities definition data.
Integrating collateral, guarantees and other credit enhancement data with items 1 and 2.
Collection and maintenance of external historic data (market data, industry defaults, etc.)
Providing audit trails and reconciliation to source systems.
Archive facilities to refine analysis and validate results. Proper data security to limit unauthorized access.
The Second Challenge: Analytics
Implementation of multiple sophisticated credit ratings models.– Scoring or Merton-style models for PD.– Behavioral models for EAD.– Structural and external conditions models for LGD.
Advanced economic capital allocation framework (Pillar II.)
Credit Exposure Map
Trading Exposure
Loans
Investments (HTM)
Traded Securities (MTM)
Residential Mortgages
Leases
Project Finance
Retail
Co
mm
erci
al
Pre-Settlement
Settl.
Ter
m
Term
Revol.
Rev
ol.
UnsecuredIlliquid Coll.Liquid Coll.
Additional Information and Analytics
Mkt Data
Vols &Correl
Static Data
DefaultAnalytics
ExposureAnalytics
LGDAnalytics
Legal &Netting
Guarantees,
Cr Derivatives
and Other
Credit Risk
Mitigants
Credit Ratings
Credit Exposure and Supporting Data
Trading Exposure
Loans
Investments (HTM)
Traded Securities (MTM)
Residential Mortgages
Leases
Project Finance
Retail
Co
mm
erci
al
Pre-Settlement
Settl.
Ter
m
Term
Revol.
Rev
ol.
Mkt Data
Vols &Correl.
Static Data
DefaultAnalytics
ExposureAnalytics
LGDAnalytics
Legal &Netting
GuaranteesCredit Ratings
Typical Existing Data Links
LineUnit 1
LineUnit 5
LineUnit 6
LineUnit 7
LineUnit 8
LineUnit 2
LineUnit 3
LineUnit 4
ControlUnit 4
ControlUnit 3
ControlUnit 2
ControlUnit 1
ControlUnit 5
Ideal Data Linkage Configuration
LineUnit 1
LineUnit 5
LineUnit 6
LineUnit 7
LineUnit 8
LineUnit 2
LineUnit 3
LineUnit 4
ControlUnit 4
ControlUnit 3
ControlUnit 2
ControlUnit 1
ControlUnit 5
• Content translation
XML Protocols FpML, NTM...
MiddlewareMQSeries, MINT...
• Bridging operating systems & network protocols
• Delivery and routing
Semantic Adapters
• Central repository for portfolio data and analytics
Practical Data Linkage Configuration
LineUnit 1
LineUnit 5
LineUnit 6
LineUnit 7
LineUnit 8
LineUnit 2
LineUnit 3
LineUnit 4
ControlUnit 4
ControlUnit 3
ControlUnit 2
ControlUnit 1
ControlUnit 5
• Content translation
• Central repository for portfolio data and analytics
• Bridging operating systems & network protocols
• Delivery and routing
Middleware
Data Mapping & Consolidation
Software
Agenda
1. Introduction – A Brief History of the Basel Accord
2. Data Issues and Technology Challenges
3. Support for Broader Trends in Risk Management
4. Solution Components to Manage Credit Risk Under Basel II
5. Importance of Communication
Evolution of Credit Risk Management
Credit Underwriting
1985 Portfolio Management
Credit Underwriting
Today
•Credit risk management was dominated by careful underwriting.
•The watchword tended to be “We only make good loans.”
•A portfolio management overlay.•Underwriting data feed portfolio management.
•Few data flow the other way.•Portfolio management is mainly strategic.
Evolution of Credit Risk Management
Portfolio Management
Credit Underwriting
Today
•A portfolio management overlay.•Underwriting data feed portfolio management.
•Little data flows the other way.•Portfolio management is mainly strategic.
In 5 to 15 Years
Portfolio Management
Credit Underwriting
•Data flow both ways.•The frequency and speed of data exchange accelerates dramatically.
•Portfolio analysis becomes a tactical decision support tool.
Data Map – Wholesale Finance
Retail
Co
mm
erci
al
Pre-Settlement
Settl.
Ter
m
Term
Revol.
Rev
ol.
Mkt Data
Vols &Correl.
Static Data
DefaultAnalytics
ExposureAnalytics
LGDAnalytics
Legal &Netting
GuaranteesCredit Ratings
Trading Exposure
Loans
Investments (HTM)
Traded Securities (MTM)
Residential Mortgages
Leases
Project Finance
Support for Tactical Decisions
Proposed Credit Facility
RAROC Implications(Including Portfolio Effects)
- Current RAROC
- Credit Enhancement Options
- RAROC Sensitivity
- Minimum Terms
Trading Exposure
Loans
Investments (HTM)
Traded Securities (MTM)
Residential Mortgages
Leases
Project Finance
Data Map - Trading Credit
Mkt Data
Vols &Correl.
Static Data
DefaultAnalytics
ExposureAnalytics
LGDAnalytics
Legal &Netting
GuaranteesCredit Ratings
Retail
Co
mm
erci
al
Pre-Settlement
Settl.
Ter
m
Term
Revol.
Rev
ol.
Simulation-Based Trading Credit Exp.
Limit Query
Trading Systems
Trade Entry
Portfolio Trade Data
Fast AnalyticExposure Calculator
Before & After Exposure Profiles and Limits
Marginal Credit Loss and Credit Capital Charges
Real-Time Process
Credit Risk Server
Summary Trade Data
Middleware & XML Messages
Agenda
1. Introduction – A Brief History of the Basel Accord
2. Data Issues and Technology Challenges
3. Support for Broader Trends in Risk Management
4. Solution Components to Manage Credit Risk Under Basel II
5. Importance of Communication
Needed Components for a Basel II Credit Solution
Data Consolidation
and Quality Control
Credit Rating Models
(PD, EAD, LGD)
Credit rating workflow
• static customer data
• financial statements
• credit ratings
Operational credit systems
environment
Loans, limits, exposure analytics, etc.
IRB regulatory and economic
capital calculations &
validation framework
Internal and external reporting
Basel II Credit Risk Architecture Overview
Exposures
Collateral
Exposures
Trading/Banking Book (Corp./Banks/Sov.)
Banking book: SME / Retail Book
Credit system
Credit system
Collateral
B2 CapitalCalculator
Internal Credit Rating
Systems
PD, EAD, LGD
Ratings and Loss Data
Regulatory Capital
CalculationsRegulatoryReporting
RegulatoryCapital
Validation Framework
RegulatoryValidationReports
Historical Data
Analysis
InternalReporting
EconomicCapital
Calculations
EconomicCapital
Allocation
Tactical Decision Support
B2
Da
ta Co
ns
olid
ator
Buy vs. Build & the Software Life Cycle
Software has a life cycle like all other products
CommoditizedProprietaryBreadth of
Usage
All
Few
Cost
High
Low
maturity
Dangerous Position
You Competitors
Agenda
1. Introduction – A Brief History of the Basel Accord
2. Data Issues and Technology Challenges
3. Support for Broader Trends in Risk Management
4. Solution Components to Manage Credit Risk Under Basel II
5. Importance of Communication
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