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Case Studies

Case Study

Pillar II - Modelling credit and concentration risk on the portfolio of a commercial bank

FOCUS ON: Case studies, Credit Risk,

The client was seeking to develop a more risk sensitive measure of credit and concentration risks for internal steering purposes, and to comply with supervisory requirements. Avantage Reply assisted the client to identify the possible methodology options, and to conduct an impact study to estimate the impact on internal capital.

THE CLIENT

The client is one of the largest financial institutions in France. It offers its clients a wide range of products and services: savings, investment, treasury, financing, insurance and investment solutions.

THE CHALLENGE

Following an ECB on-site inspection, many findings pointed to the inadequate quantification approach for the evaluation of credit and concentration risks. In this context, the institution decided to launch a quantitative study to assess what would be the most appropriate quantitative approach to assess credit and concentration risks regarding the nature and the diversity of institutions’ portfolio.

APPROACH AND SOLUTION

Avantage Reply started its study by elaborating a benchmark of market practices in terms of credit risk quantification methodologies. In conjunction with scientific literature, several methodology options were proposed and discussed, including HHI index formula, Gordy granularity adjustment, tailored correlation parameters, and full credit portfolio model. Through various dedicated workshops and iterations, it was decided to test two different approaches to build tailored correlation parameters:

  • An extension of an asymptotic single risk factor model that recognises diversification or concentration based on the single factor Merton model.
  • A correlation matrix calibration, with the default rate correlation-based mode as in this modelling approach, and the correlation matrices estimated based on the Vasicek analytical equations using the empirical default rate (TD) for each category.

For each approach, our team has implemented a computerised mock-up to assess the impacts in terms of internal capital on a portfolio sample. At the end of this first phase of the project, further R&D investigations were still necessary to evaluate the internal capital impacts on the entire portfolio.

RESULTS AND BENEFIT

Through its practical experience and various elements of best practices, Avantage Reply has completed this study in line with client’s expectations. Both approaches have been specified and tested as the outcomes of the simulations and have allowed the client to demonstrate potential savings in terms of internal capital and a better measure of concentration/diversification of the portfolio. Being still in an R&D phase, our team has gathered a list of areas of improvements to integrate both approaches in the system.

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IRRBB – Support the transition of the IRRBB metrics computation tool and reconciliation exercise between both outcomes regarding EVE (Economics Value of Equity) and NII (Net Interest Income).

The Client, a huge international bank, request the support of Avantage Reply to further understand and quantify the differences arising between both of their IRRBB metrics calculators. The first, is a hand-made tool provided by the headquarter and the second is a well-known risk software solution used locally. Avantage Reply helps isolating and assessing each of the differences, and in case of materiality, set processes in order to compute overlays. Avantage Reply further helps to add and validate missing products. Validations cover parametrization of the tool, alinement of IRRBB inputs (margin and reference rate) and models (non-maturing products, prepayment, caps, floors,..)

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IFRS 9 Control Framework

The customer is a retail belgian bank focusing on mortgage loans and consumer credit. Following the implementation of the IFRS 9 ECL calculator, the need arised to implement a control framework to ensure timely and quality calculation and bookings, and integration in the accounting and reporting platforms. Avantage Reply helped the client bridge the distance between different departments to identify the right responsibilities at the right moment in the process to increase its reliability.

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Internal Audit Co-Sourcing - COREP

The customer is a strong financial player present worldwide providing services in banking sector and insurance. The goal of the project was to conduct a co-sourcing Internal Audit on Common Reporting (Corep). Avantage Reply provided the client with a tailored assistance to its specific needs bringing its expertise and knowledge in order to perform high quality assessment of Corep governance processes.

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