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

Scott D Aguais, Lawrence R Forest Jr, Martin King, Marie Claire Lennon and Brola Lordkipanidze

INTRODUCTION

Since the first edition of The Basel Handbook was published in early 2004, major internationally active banks around the world have continued to engage in substantial projects for designing and implementing the extensive Basel II framework. To achieve the advanced internal ratings based (AIRB) status, banks need to develop a variety of credit models that estimate, for each obligor, probability of default (PD) and, for each credit exposure or facility, loss given default (LGD) and exposure at default (EAD). In developing the required PD models, many banks have had to redesign or refine their risk-rating approaches. In this process, banks have found it necessary to determine whether various PD measures are “point-in-time” (PIT), “through-the-cycle” (TTC) or a hybrid, somewhere between PIT and TTC.²²For the purposes of this chapter, we will generally use PD to refer to both “credit ratings” and probabilities of default. Further below, we explain some more subtle differences between these two concepts.

In the first edition of The Basel Handbook, we contributed a chapter that introduced concepts for thinking about PIT–TTC PD issues and presented preliminary empirical