BASEL II: PROBLEMS AND USAGE

Small and medium-sized universal banks prefer to use the less sophisticated
Standard Approach.
Hence, despite the fact that Quantitative Impact Studies (QIS), which
were conducted to assess the impact of Basel II on the banks’ capital requirements,
revealed that the use of the advanced methods would be especially
beneficial for small and medium-sized banks, 25 these banks prefer to
use the Standard Approach. It is worth mentioning that there is a possibility
of partial use of the IRBA, according to which the banks can implement the
rating systems on a step-by-step basis within a period of five years. Actually,
the average implementation period in case of the partial use constitutes
three years.
Although the number of rating systems submitted for approval ranges
from one to 50, the most common methods are expert systems, simulation
models, and credit scoring systems. 26 The latter use quantitative and qualitative
data in order to assign a score to a borrower, which reflects his creditworthiness.
The most popular statistical tools employed are discriminate
analysis and probability models. 27 Scoring systems are primarily used in
retail business and for small and medium-sized enterprises. Expert systems
are applied to evaluate the credit risk of large corporate borrowers. Finally,
simulation methods are employed for specialized lending and project finance.
In practice, a mixture of all three methods is also used. 28
5.2. Model Validation Techniques
Whichever of the aforementioned internal ratings-based methods is
applied to model the credit risk, it has to be of high quality to ensure the
correct reflection of the bank’s credit risk exposure. Various validation
techniques were developed to evaluate the quality of internal rating models.
Basel II devotes special attention to the validation issue; banks applying for
IRBA implementation have to convince the supervisor in the appropriateness
of their models. One way of validating the rating model is to measure
its discriminative power, i.e. the ability to distinguish between defaulters
and non-defaulters. The most popular validation techniques include the
Cumulative Accuracy Profile (CAP) and the Receiver Operating Characteristic
(ROC). 29
25 See Deutsche Bundesbank (2006).
26 See Deutsche Bundesbank (2009).
27 These models include the linear probability model, the logit model, and the probit
model.
28 See Deutsche Bundesbank (2009).
29 This subsection is based on Beinert/Reichling/Vogt (2007).
30