Rating Models and Validation - Oesterreichische Nationalbank

during the realization period. The bankÕs individual cost of equity can be used
for this purpose.
If an institution decides to calculate opportunity costs due to lost equity, it
can include these costs in the amount of profit lost (after calculating the riskadjusted
return on equity).
Workout Costs
In order to estimate workout costs, it is possible to base calculations on internal
cost and activity accounting. Depending on how workout costs are recorded in
cost unit accounting, individual transactions may be used for estimates. The
costs of collateral realization can be assigned to individual transactions based
on the transaction-specific dedication of collateral.
When cost allocation methods are used, it is important to ensure that these
methods are not applied too broadly. It is not necessary to assign costs to specific
process steps. The allocation of costs incurred by a liquidation unit in the retail
segment to the defaulted loans is a reasonable approach to relatively homogenous
cases. However, if the legal department only provides partial support for liquidation
activities, for example, it is preferable to use internal transfer pricing.
In cases where the bankÕs individual cost and activity accounting procedures
cannot depict the workout costs in a suitable manner, expert estimates can be
used to calculate workout costs. In this context, it is important to use the basic
information available from cost and activity accounting (e.g. costs per employee
and the like) wherever possible.
When estimating workout costs, it is advisable to differentiate on the basis of
the intensity of liquidation. In this context, it is sufficient to differentiate cases
using two to three categories. For each of those categories, a probability of
occurrence can be determined on the basis of historical defaults. If this is not
possible, the rate can be based on conservative expert estimates. The bank
might also be able to assume a standard restructuring/liquidation intensity
for certain customer and/or product types.
7.5 Developing an LGD Estimation Model
The procedural model for the development of an LGD estimation model consists
of the following steps:
1. Analysis of data availability and quality of information carriers
2. Data preparation
3. Selection of suitable estimation methods for individual loss parameters
4. Combination of individual estimation methods to create an overall model
5. Validation
Data availability and quality are the main limiting factors in the selection of
suitable methods for LGD estimation. As a result, it is necessary to analyze the
available data set before making decisions as to the type and scope of the estimation
methods to be implemented. In the course of data preparation, it may
also be possible to fill gaps in the data set. The quality requirements for the data
set are the same as those which apply to PD estimates.
Loss data analyses are frequently complemented by expert validations due to
statistically insufficient data sets. A small data set is generally associated with a
high degree of variance in results. Accordingly, this loss of precision in the inter-
Rating Models and Validation
Guidelines on Credit Risk Management 157