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Most of the companies they interact with banks adopting IRB approach, that is a personal evaluation, enabling the Bank to determine some internal estimates of risk of individual counterparties or types of transactions with the same technical characteristics. All this happens with a set of methods, processes, controls before and after, all the historical data maintained ranging from computer systems to analyze credit risk, the allocation of internal degrees of creditworthiness, and the estimated probability of defaults and losses expected over a given period of time.
The distinction between the economic players vary according to:
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type of debtor
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sovereign governments
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banks
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public
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companies
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SMEs
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detail
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type of operation
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receivables
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equity exposure
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revolving credits
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securitization
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project financing
The structure of the calculation of the rating takes a set of risk components, common to all operations.
Component PD that represents a percentage value that indicates the likelihood of default by the customer.
Component LGD , which represents a percentage value that provides an estimate of loss given default for each exposure. It starts from a starting point, giving the senior lenders a rate of 45% and subordinated loans to a percentage of 75%, which are still influenced (for better and for worse) from a number of elements of subjective evaluation, which :
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mitigation of risk arising from guarantees and credit derivatives
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recessionary conditions in the economic cycle
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cyclicality of the business cycle
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historical rates of recovery
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measurement of the economic losses (including discounts on the face, direct and indirect costs associated with collecting the loan)
Component EAD , which is the value expressed in foreign currency (Euro) indicating the expected exposure at the time of the failure of the obligation.
Component M , residual maturity of the merger, in terms of years, with an average start of 2.5.
Component G , which represents the degree of concentration of the portfolio of bank loans.
These values \u200b\u200bare analyzed and related weighting function, which incorporates the mathematical functions of risk weights to quantify the burden ( RWA ) transaction.
A rating function, then it could be transcribed:
credit RWA = k * 12.5 * EAD
with, for the formulation of weighting corporate exposures:
Correlation (R) = 0.12 * (1-EXP (-50 + PD)) / (1-EXP (-50)) + 0.24 * [1 - (1-EXP (-50 *
PD)) / (1-EXP (-50))] (with an adjustment for SMEs : companies that are part of a Group with turnover
less than € 50 million)
adjustment according to maturity (b) = (0.11852-0.05478 * Ln (PD)) ^ 2 and the capital requirement (k) = [LGD * N [(1-R) \u200b\u200b^ -0 , 5 * G (PD) + (R / (1-R)) ^ 0.5 * G (0.999)] - PD * LGD] * (1-1.5 * b) ^ -1 * (1 + ( M-2, 5) * b) with N (x) and G (z) and inverse normal distribution function in practice, k = f (PD, LGD, M).
the expected loss from the bank, that the damage will probably determined by granting a loan, it is apparent from the following formula:
expected loss rate ELR = PD * LGD remember where PD is the probability of failure customer and LGD estimation of the percentage of loss.
Expected Loss EL = ELR * EAD EAD where is the value expressed in foreign currency (Euro) indicating the expected exposure at the time of the failure of the obligation.
As we have seen the variables involved are many and not all certain, objective fact, the bank must make an estimation process to assess the PD component, component LGD and EAD for each grade component of the internal credit rating (Enterprise) for each grouping of exposures (for retail).
This activity of internal estimate is based on:
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historical experience and empirical evidence
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subjective and discretionary.
Subjectivity is important and is primarily a policy for managing the bank's footprint, meaning that affected of the market where the bank operates and the approach that it wants to have with it. For example, if the bank operates in a market composed primarily of small businesses, has refined its assessment of SMEs at the expense of the evaluation of major economic, or if you have a vocation "retail" will be more able to assess the individual, rather that an economic reality, however large or small.
In their generality, we then either to a bank that operates in the retail sector and businesses, the process of determining the rating takes into account three main elements Basic:
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Customer
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the type of transaction (EAD), for splitting classes amount
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guarantee (LGD), to understand what really puts at risk the bank, the value that is not covered by warranty option (personal or real).
If the Customer that is one on which you based this book, every single economic entity is inserted in a given rating category based on an evaluation process that examines:
