Rating Models and Validation - Oesterreichische Nationalbank
Rating Models and Validation - Oesterreichische Nationalbank
Rating Models and Validation - Oesterreichische Nationalbank
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<strong>Rating</strong> <strong>Models</strong> <strong>and</strong> <strong>Validation</strong><br />
II ESTIMATING AND VALIDATING<br />
PROBABILITY OF DEFAULT (PD)<br />
1 Defining Segments for Credit Assessment<br />
Credit assessments are meant to help a bank measure whether potential borrowers<br />
will be able to meet their loan obligations in accordance with contractual<br />
agreements. However, a credit institution cannot perform credit assessments<br />
in the same way for all of its borrowers.<br />
This point is supported by three main arguments, which will be explained in<br />
greater detail below:<br />
1. The factors relevant to creditworthiness vary for different borrower types.<br />
2. The available data sources vary for different borrower types.<br />
3. Credit risk levels vary for different borrower types.<br />
Ad 1.<br />
Wherever possible, credit assessment procedures must include all data <strong>and</strong><br />
information relevant to creditworthiness. However, the factors determining creditworthiness<br />
will vary according to the type of borrower concerned, which<br />
means that it would not make sense to define a uniform data set for a bankÕs<br />
entire credit portfolio. For example, the credit quality of a government depends<br />
largely on macroeconomic indicators, while a company will be assessed on the<br />
basis of the quality of its management, among other things.<br />
Ad 2.<br />
Completely different data sources are available for various types of borrowers.<br />
For example, the bank can use the annual financial statements of companies<br />
which prepare balance sheets in order to assess their credit quality, whereas this<br />
is not possible in the case of retail customers. In the latter case, it is necessary to<br />
gather analogous data, for example by requesting information on assets <strong>and</strong> liabilities<br />
from the customers themselves.<br />
Ad 3.<br />
Empirical evidence shows that average default rates vary widely for different<br />
types of borrowers. For example, governments exhibit far lower default rates<br />
than business enterprises. Therefore, banks should account for these varying levels<br />
of risk in credit assessment by segmenting their credit portfolios accordingly.<br />
This also makes it possible to adapt the intensity of credit assessment according<br />
to the risk involved in each segment.<br />
Segmenting the credit portfolio is thus a basic prerequisite for assessing the<br />
creditworthiness of all a bankÕs borrowers based on the specific risk involved.<br />
On the basis of business considerations, we distinguish between the following<br />
general segments in practice:<br />
— Governments <strong>and</strong> the public sector<br />
— Financial service providers<br />
— Corporate customers<br />
¥ Enterprises/business owners<br />
¥ Specialized lending<br />
— Retail customers<br />
8 Guidelines on Credit Risk Management