The client, a public lending bank, wanted to introduce two new products to its portfolio and needed to conduct a risk assessment in order to determine the bank’s capital needs for these new products. The main problem was that the client had no internal data to support such an assessment. Using historic statistical data, AR provided the client with a model that allowed to assess the risks associated with these products and determine the capital needs for these products.
The customer wanted to introduce two new lending products to its portfolio, one being a guarantee for commercial bank loans and the other an expansion of existing specialized lending products due to the COVID-19 outbreak.
The main goal of the project was to develop a methodology to quantify the risks associated with these two products and derive from this methodology an estimate for the own funds required to support said products.
The main challenge of the project was the lack of historical customer data at the bank. Due to its small scale, the bank did not have sufficient internal data to make a reliable estimate of the parameters needed for the risk assessment (e.g. Probability of default of the prospective borrowers). Additionally, the increased uncertainty under the economically damaging pandemic was difficult to consider in the model development.
By researching statistical data relevant for the products to be assessed, estimates for the probability of default and loss given default based on the characteristics of the product and its target market could be made. The overall size of the loan portfolio, the financial instrument details and the prospective customer base were defined by the client. Using these estimated and the risk-weighted assets approach, Avantage Reply calculated the maximal loss amounts for the products and simulated a portfolio of loans as a plausibility check for the assumptions. The capital requirements for the two products were derived using these estimates of risk-weighted assets.