Explaining the Credit Risk Elements in Basel II

Simon Hills and Ross Barrett

Contents
1.

Development and Validation of Key Estimates for Capital Models

2.

Explaining the Correlation in Basel II: Derivation and Evaluation

3.

Explaining the Credit Risk Elements in Basel II

4.

Loss Given Default and Recovery Risk: From Basel II Standards to Effective Risk Management Tools

5.

Assessing the Validity of Basel II Models in Measuring Risk of Credit Portfolios

6.

Measuring Counterparty Credit Risk for Trading Products under Basel II

7.

Implementation of an IRB-Compliant Rating System

8.

Stress Tests of Banks’ Regulatory Capital Adequacy: Application to Tier 1 Capital and to Pillar 2 Stress Tests

9.

Advanced Credit Model Performance Testing to Meet Basel Requirements: How Things Have Changed!

10.

Designing and Implementing a Basel II Compliant PIT–TTC Ratings Framework

11.

Basel II in the Light of Moody’s KMV Evidence

12.

Basel II Capital Adequacy Rules for Retail Exposures

13.

IRB-Compliant Models in Retail Banking

14.

Basel II Capital Adequacy Rules for Securitisations

15.

Regulatory Priorities and Expectations in the Implementation of the IRB Approach

16.

Market Discipline and Appropriate Disclosure in Basel II

17.

Validation of Banks’ Internal Rating Systems – A Supervisory Perspective

18.

Rebalancing the Three Pillars of Basel II

19.

Implementing a Basel II Scenario-Based AMA for Operational Risk

20.

Loss Distribution Approach in Practice

21.

An Operational Risk Rating Model Approach to Better Measurement and Management of Operational Risk

22.

Constructing an Operational Event Database

23.

Insurance and Operational Risk

Modern banking is built on the sensible premise that holding a large portfolio of loans held together is less risky than one held on its own. While some borrowers may default, the loss of principal should be more than offset by the interest received from those that do not. Credit risk is the major risk to which banks are exposed – making loans or taking on credit exposure, perhaps by way of a derivative transaction, is the principal activity of most banks – and it has confounded bankers since the first loan was made.

Credit risk is the risk to a bank’s earnings or capital base arising from a borrower’s failure to meet the terms of any contractual or other agreement it has with the bank. It arises from all activities where success depends on counterparty, issuer or borrower performance.

Credit risk is present at any time a bank has funds extended to, invested in, or otherwise committed to a counterparty, whether reflected on or off the balance sheet. Credit risk arises because, in extending credit, banks have to make judgements about a borrower’s creditworthiness – its ability to pay principal and interest when due. This creditworthiness may decline over time due to poor

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