TAILIEUCHUNG - Using Credit Risk Models for Regulatory Capital: Issues and Options

These capital requirements were notable because, for the first time, regulatory minimum capital requirements could be based on the output of banks’ internal risk measurement models. The market risk capital requirements thus stood in sharp contrast to previous regulatory capital regimes, which were based on broad, uniform regulatory measures of risk exposure. Both supervisors and the banking industry supported the internal-models-based (IM) market risk capital requirement because firm-specific risk estimates seemed likely to lead to capital charges that would more accurately reflect banks’ true risk exposures. That market risk was the first—and so far, only— application of an IM regulatory capital regime is not surprising, given the relatively advanced state of market risk. | Beverly J. Hirtle Mark Levonian Marc Saidenberg Stefan Walter and David Wright Using Credit Risk Models for Regulatory Capital Issues and Options Regulatory capital standards based on internal credit risk models would allow banks and supervisors to take advantage of the benefits of advanced risk-modeling techniques in setting capital standards for credit risk. The internal-model IM capital standards for market risk provide a useful prototype for IM capital standards in the credit risk setting. Nevertheless in devising IM capital standards specific to credit risk banks and supervisors face significant challenges. These challenges involve the further technical development of credit risk models the collection of better data for model calibration and the refinement of validation techniques for assessing model accuracy. Continued discussion among supervisors financial institutions research economists and others will be key in addressing the conceptual and theoretical issues posed by the creation of a workable regulatory capital system based on banks internal credit risk models. In January 1996 the Basel Committee on Banking Supervision adopted a new set of capital requirements to cover the market risk exposures arising from banks trading activities. These capital requirements were notable because for the first time regulatory minimum capital requirements could be based on the output of banks internal risk measurement models. The market risk capital requirements thus stood in sharp contrast to previous regulatory capital regimes which were based on broad uniform regulatory measures of risk exposure. Both supervisors and the banking industry supported the internal-models-based IM market risk capital requirement because firm-specific risk estimates seemed likely to lead to capital charges that would more accurately reflect banks true risk exposures. That market risk was the first and so far only application of an IM regulatory capital regime is not surprising given the .

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