DEVELOPMENT OF A DOWNTURN LGD MODEL
Background & Challenges
In light of changes to the Basel regulations, particularly regarding the scope of credit risk, the client has launched two major initiatives:
- New Definition of Default
- Basel Developments
As part of the “Evolutions Bâloises” program, our client’s Risk and Internal Control Department sought assistance in implementing a methodology for estimating LGD downturn and conservatism margins for four of its subsidiaries in Europe.
The objectives of the mission were as follows:
- Gaining a Better Understanding of Banking Regulations on the Calculation of Downside LGD Through the Preparation of a Methodological Note
- Propose methodological solutions that take the new regulations into account
- Conduct an impact assessment of the new regulations
- Support subsidiaries in implementing the new regulations and the proposed methodological solutions
Solution
Our methodological approach was based on close collaboration with the steering and development teams within the Risk Management Department and with the development teams at our subsidiaries across Europe. It drew on our expertise in banking regulations, our experience in the operational implementation of new banking regulations, and our track record in developing new credit risk models. Our approach enabled the client to benefit from our knowledge of the methodologies most commonly used by banks and accepted by European banking supervisors.
The proposed measures and actions taken were as follows:
- Proposal for a procedure to implement the project for calculating downturn LGD in four subsidiaries, three of which are based overseas;
- Methodological proposals:
- Methods for identifying periods of economic crisis (nature, severity, and duration)
- Estimation methods for Approach 1 (based on observed impacts) and Approach 2 (based on estimated impacts)
- Implementation of Approaches 1, 2, and 3 (recalibration of LGD and calculation of downturn LGD)
- Impact Assessment of the Three Approaches
- Documentation of the methodology, codes, and test results
- Active participation in the Working Group (WG) organized by the client to present our methodological proposals and the results of the impact studies;
- Coordinating communication and the teams involved in estimating the downturn LGD;
- Training and supporting modeling teams at subsidiaries in the rollout of the proposed and implemented methodology.
Benefits for the customer:
Our approach enabled our client to better understand the new regulations and implement them on schedule while building in-house expertise.
The work carried out by Quanteam enabled the client to:
- to understand the new banking regulations regarding the calculation of LGD in a downturn
- to have a methodological note on the calculation of the downturn LGD
- to have an impact assessment of the new capital adequacy regulations
- to train model development teams on the proposed and implemented methodologies
In summary: The work carried out to implement the LGD downturn has enabled the client to comply with the new banking regulations.
Quanteam’s expertise makes all the difference
- Extensive knowledge of the European banking and regulatory environment
- An experience with the implementation of new banking regulations
- Proven expertise in credit risk modeling
- Experience in project management and collaborating with international teams
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