Credit Models: Basel & Solvency 2

Credit risk analysis is complex because data is always scarce and not fully representative of the future. Therefore no single data set will suffice and multiple sources of information (varying from internal data to expert input) are needed.

A dedicated statistical framework is required to combine these multiple sources coherently and an accomplished analyst will need to account for uncertainty in the model inputs.

One consistent framework for many applications

At OSIS, we have created a framework based on Bayesian Statistics, which in essence is more conservative than any traditional approach. However, if many data sources of good quality are used, it does not necessarily lead to more conservative outcomes (see our use case where we updated the Basel 2 model with the default frequencies of 14 banks).

In our modeling approach we distinguish several ways credit risk is measured in the financial industry, which seem very different, but in essence are very similar:

  1. RegCap or Ecap approach: this is loss-based on accounting principles (Basel 3) or spread movements (Solvency 2) measured over a one year horizon, irrespective at what point of the cycle, at a high confidence interval of 99.5% or higher.
  2. IFRS9 loan loss provision: a cumulative loss on the lifetime of a loan at a 50% confidence level.
  3. Stress testing: losses projected over several years into the future, conditional on certain macro scenario’s at a 50% confidence level.
  4. Securitization: a cumulative loss at multi-year horizon, conditional on a macro scenario (OSIS) or unconditional (CRA) at different confidence levels dependent at the tranche level and tranche maturity.

Therefore the statistical approach of these measurements should use the same building blocks in order to get to consistent and comparable outputs.

LoanPilot™

Our model framework LoanPilot™ is based on one model engine using different modules for each measurement. LoanPilot™ is automatically updated once new loan level reports become available. Therefore LoanPilot™ can be used by a broad group of market participants including banks, insurers and investors.

LoanPilot™ can be made available through a secure portal or can be installed on the systems of our clients. Ideally it remains connected with a database where new loan level data is added in order to have the model automatically updated.

LoanPilot™ can interact with vendor ABS cash flow models to meet regulatory due diligence requirements or can be used for stress testing securitization transactions.