Development and implementation of the IRB-models

SUMMARY

Avantage Reply supported a large bank with a complete transformation of the internal credit risk model portfolio. In doing so, our team was involved in several steps of the model lifecycle: model development, model backtesting, model validation by the second line of defense, model review by the ECB and implementation of the model in the bank’s IT system.

CUSTOMER GOALS

The client launched a multi-year program, with the aim of reshaping the bank’s internal credit risk models’ landscape for all its entities. This in-depth transformation of the internal model’s portfolio had three main objectives:

• Simplifying the model landscape;
• Harmonizing approaches across entities, and
• Ensuring compliances with the latest regulations

The program consisted of several phases, each phase dedicated to a different set of models and credit portfolios.

CHALLENGES

Our team faced several challenges while working on the transformation of the client’s IRB models, such as a lack of harmonization of the applied approaches for IRB models across all entities, defining the application of the methodology for Low Default Portfolios (LDP), ensuring the appropriateness of the statistical analysis, the correct treatment of incomplete recoveries and short deadlines assigned to each phase of the program.

SOLUTION

Avantage Reply started the assignment with an extensive review of the client’s existing IRB models against the current guidelines. In doing so, we created an excel-based report which assessed the compliance of the current IRB models against every requirement of the EBA guidelines on PD and LGD estimation (EBA/GL/2017/16).

Our team conducted the following tasks while working on the development of a new LGD model for the SME portfolio:

• Definition of all relevant portfolios in the scope of the new model,
• Definition of the methodology for the SME LGD model,
• Data gathering and data cleaning ,
• Estimation of the transition rate model,
• Estimation of Loss Given Recovery Default and Loss Given Non-recovery Default, Margin of Conservatism (MOC) and downturn component,
• Implementation of the survival rate approach for the treatment of incomplete recoveries,
• Performance assessment of the new model,
• Calculation of the RWA impacts of the new model,
• Development of full model documentation that included qualitative and quantitative data assessments, a description of the IT infrastructure, model development process, performance assessment, and RWA impact.

After completing the model development phase, our team was involved in the validation of the new model by the second line of defense and remediation of their findings. Following the review of the model, we performed the backtesting of the new SME LGD model, including a report presenting all data and codes were presented to the second line of defense. Both development and backtesting of the SME LGD model were done in SAS Enterprise Guide.

Avantage Reply’s team was also involved in the validation of the new IRB model by the ECB. During the internal model review, we were responsible for providing the supervisory team will all relevant data, code, and analysis that were used in model development and model backtesting, In addition, we performed various additional analysis requests by the ECB team.

Finally, our team supported the client in the implementation of the new model in the bank’s IT system.