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How to Build an Internal Rating System for Basel II Aidan O’Mahony Managing Director Tel: +44 207 826 3518 Standard & Poor’s Risk Solutions
Risk Solutions was formed in 2001 in response to client demand for tools and services to better manage credit risk exposures. Risk Solutions is the customised risk management services arm of Standard & Poor’s focusing on: 1. Customised Credit Services (internal rating systems) 2. Credit Tools, Models, Data & Research (eg Pd & LGD) 3. Credit Training (Open enrolment and Custom Courses). Standard & Poor’s Risk Solutions
What is an Internal Rating System ? Consistent rating approach across all classes Desk-top IT application – intranet delivered across an organisation Analytical and Management tool for tracking credit exposures and linking into Raroc models Satisfies Basel II Internal Ratings-Based Approach requirements
Satisfy board regarding the validity of an internal rating system Identify areas of inconsistency in order to improve an internal ratings process Backtest model results versus S&P ratings or estimates Compare results and map the scales Backtesting and Mapping to External Indicators of PD Large corporates and specialised lending Sample template – Insurance Companies 6 5 4 3 2 1 23.76 CCC 5.44 B 0.88 BB 0.19 BBB 0.02 A 0.02 AA 0 AAA 1-yr PD S&P 4 1 CCC 2 4 1 2 B 1 6 1 BB 1 5 BBB 1 5 A 1 2 3 AA 1 AAA 6 5 4 3 2 1
In the experience of S&P Risk Solutions, over the last few years, banks have adopted different modelling techniques which in turn produce results in different scales.
Once an internal model is in place, it is important to ensure that the choice of methodology is adequate to the bank’s requirements / data, and that the methodology is applied consistently and produces reliable results