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BCBS Paper of PDLGD and EAD PDF
BCBS Paper of PDLGD and EAD PDF
FSI Award
2010 Winning Paper
Regulatory use of system-wide
estimations of PD, LGD and
EAD
Jesus Alan Elizondo Flores
Tania Lemus Basualdo
Ana Regina Quintana Sordo
Comisión Nacional Bancaria y de Valores,
Mexico
September 2010
E-mail: fsi@bis.org
Tel: +41 61 280 9989
Fax: +41 61 280 9100 and +41 61 280 8100
This publication is available on the BIS website (www.bis.org).
ISSN 1684-7180
Foreword
Foreword ..................................................................................... i
1. Introduction ...................................................................... 1
2. System-wide PD, LGD and EAD...................................... 2
3. System-wide information and PD, LGD and EAD
models.............................................................................. 6
4. Empirical results............................................................. 10
5. Model applications ......................................................... 15
5.1 Credit card portfolio reserves............................... 15
5.2 System-wide PD dependency on idiosyncratic
and cyclical factors............................................... 20
5.3 Bank IRB model comparison to system-wide
model estimates................................................... 29
5.4 Risk return analysis of the credit card portfolio.... 32
5.5 Differences in point-in-time (PIT) models and
through-the-cycle (TTC) estimations ................... 38
6. Conclusions.................................................................... 42
Annex 1: Explanatory variables................................................ 44
Annex 2: Reserve requirement rule ......................................... 66
Bibliography.............................................................................. 69
1
Caruana (2010).
2
Basel (2009).
3
Basel (2006).
4
Retail exposures.
5
Basel (2005).
6
However once these parameters are estimated, they can be further used
in subsequent research to explore inter-linkages among institutions using
a framework to assess systemic financial stability as defined by
Segoviano and Goodhart (2009).
7
The formula used to determine the simple size of the credit card portfolio
N z2 / 2 P (1 P )
is: n .
(N 1)e 2 z2 / 2P (1 P )
LGD model
LGD is the credit loss incurred if an obligor defaults and is
dependent on the characteristics of the loan. Losses are
influenced by the presence of collateral and when no collateral
exists the cash flows that the borrower pays after default
determine the LGD of the loan.
The model proposed to estimate LGD for the credit card
portfolio analyzed is to account for the cash flows that occur
three months after default and compare them to the maximum
outstanding balance of the loan after the moment of default.
8
Hosmer and Lemeshow (1995).
EAD model
EAD estimates the percentage of exposure the bank might
lose if the borrower defaults. The estimation of EAD becomes
highly relevant in revolving instruments such as credit cards
and hence it is necessary to include an estimation of the value
of the exposure that the borrower will have at the time of
default in order to obtain an appropriate estimate of the
expected loss. Commonly used methods of estimation for this
parameter9 are focused in metrics that associate the
increments in the balance between a specific date of reference
and the time of default. The model proposed in this document
consists of estimating an exposure at default factor that
reflects the multiple of the outstanding balance at the moment
of default to the outstanding balance at the reference point
(EAD factor).
Considering that the credit limit use at the reference point date
is a candidate to explain significant differences in the EAD
factor, a simple statistical association between both variables
is proposed as follows:
9
Engelmann and Rauhmeier (2006).
4. Empirical results
PD model
The independent variables used to build the PD model were
constructed from the data set mentioned before and were
selected according to their explanatory power. For an
exhaustive list of variables analyzed see Annex 1.
The PD model contains the following five variables:
1. X1: number of consecutive periods, up to the reference
point, in which the cardholder has not paid its minimum
contractual payment obligation;
2. X2: number of periods in which the cardholder has not
covered the minimum payment in the last 6 months.
3. X3: payments made by the cardholder as a proportion
of the outstanding balance of the credit card at the
reference point;
4. X4: total outstanding balance as a proportion of the
credit limit at the reference point; and
5. X5: number of months elapsed since the issuance of the
credit card by the bank.
Intercept –2.970***
X1 Current non-payment 0.673***
X2 Historical non-payment 0.469***
X3 Percentage of payment –1.022***
X4 Credit limit use –1.151***
X5 Maturity –0.007***
Note: Significance level *** 0.001, ** 0.01, * 0.05 (performed with standard
Wald test).
LGD model
The estimation of LGD considered all the credit cards that
defaulted in the performance period and the reference point.
Table 2 shows the average amount recovered by the banks in
the three-month period after default.
% of Recovery Frequency %
Interval % Recovered
The final LGD estimate for the systemic credit card portfolio
is 81%.
EAD model
The association between the EAD factor and credit limit use is
apparent, as illustrated in Graph 1.
30
25
Factor = EAD/BalanceT0
20
15
10
0
0% 50% 100% 150% 200% 250% 300%
BalanceT0/CreditLine
0.5784
Outstandin g Balance at reference point
EAD factor
Credit limit at reference point
% USE
Credit limit Mid–point Fitted curve1
use
0%–10% 5% 566%
10%–20% 15% 300%
20%–30% 25% 223%
30%–40% 35% 184%
40%–50% 45% 159%
50%–60% 55% 141%
60%–70% 65% 128%
70%–80% 75% 118%
80%–90% 85% 110%
90%–100% 95% 103%
>=100% 100% 100%
1 b
The curve was fitted by OLS by transforming the equation: y = cx . The
significance level of the b parameter (t-test) is .0001.
Table 4
Credit card reserve requirement
0 0.5%
1 10%
2 45%
3 65%
4 75%
5 80%
6 85%
7 90%
8 95%
9 or more 100%
10
IASB (2009).
Reserves
%
12-month at start of Months of
1 Write-offs /
write-offs 12-month coverage
1 Reserves
period
Graph 2
Loan loss distribution and capital
and reserve requirement
Reserves
9.31%
Expected Loss
FREQUEN CY
18.42%
Capital Requirement + Reserves
(Standard Approach)
17.31%
% Assets
8% risk weigthed Assets
18.12 % risk weigthed Assets
%
Capital
% %
Require-
% Capital Expected
ment
Reserves Require- Loss
(System-
(Table 4 ment (System-
wide model
approach) (Standard wide model
approach in
approach) approach)
IRB
formulas)
Intercept –2.826**
Current non-payment 0.675**
Historical non-payment 0.486**
Percentage of payment –0.009**
Credit limit use –1.063**
Maturity 1.008**
Dummy bank 9 0.504*
Dummy bank 10 0.575**
Note: Significance level *** 0.001, ** 0.01, * 0.05 (performed with Wald Test).
Table 8
Individual bank PD model estimates
Current Historical
Percentage Credit Limit
Intercept Non- Non- Maturity ROC
of payment Use
Payment Payment
Graph 3
Compound annual growth rate (CAGR)
of bank portfolios
Billions
1,200
1,000
800 Commercial
CGAR = 8.19%
600
Consumer
400 CGAR = 29.46%
Mortgage
200 CGAR = 20.48%
-
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
4.2 1.35
1.30
4
1.25
3.8
1.20
3.6
1.15
3.4
1.10
3.2 1.05
3 1.00
D E F M A M J J A S O N D E F M A M J J A S O N
2005 2006 2007
Bank credt cards (left axis) Mortgage (right axis) Car (right axis)
800,000
700,000
600,000
500,000
400,000
300,000
200,000
100,000
0
1 2 3 4 5 6 7 8
Number of Credit Cards
Graph 6
Number of institutions offering credit card loans
Number of Institutions
18 20%
17 18%
Default rate
16 16%
15 14%
14 12%
13 10%
200604
200605
200606
200607
200608
200609
200610
200611
200612
200701
200702
200703
100 18%
Default rate
95 16%
90 14%
85 12%
80 10%
200604
200605
200606
200607
200608
200609
200610
200611
200612
200701
200702
200703
Maturity Bureau Default rate
Table 9
Average age of population in the credit bureau
Explanatory variables Coefficient
Intercept 0.874**
X1 Current non-payment 0.682***
X2 Historical non-payment 0.495***
X3 Percentage of payment –1.008***
X4 Credit limit use 0.951***
X5 Maturity –0.010***
Maturity bureau –0.037***
Note: Significance level *** 0.001, ** 0.01, * 0.05.
Intercept –3.706***
X1 Current non-payment 0.685***
X2 Historical non-payment 0.492***
X3 Percentage of payment –1.011***
X4 Credit limit use 0.936***
X5 Maturity –0.011***
Number of institutions 0.082***
Note: Significance level *** 0.001, ** 0.01, * 0.05.
Graph 8
IRB model PD estimates as compared to PD estimates
using the system-wide model
IRB 5.0%
4.5%
4.0%
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0.0%
0.0% 1.0% 2.0% 3.0% 4.0% 5.0%
System wide PD Model
Graph 9
Bank’s IRB estimates and system-wide model of PD
estimates for different indebtedness levels
14%
12%
10%
8%
PD
6%
4%
2%
0%
0% 20% 40% 60% 80% 100%
%Indebtness Level
PD_System_Model PD_IRB
14%
12%
10%
PD
8%
6%
4%
2%
0%
0% 20% 40% 60% 80% 100%
Payment Behavior
PD_System_Model PD_IRB
40% 1
7
30%
9
8
2 3
6
20% 5
10%
0%
0% 10% 20% 30% 40% 50% 60%
Expected Loss
Graph 13
Ex ante PD estimates and interest rates
100% 40.0%
S p r e a d o v e r i n te r b a n k
80%
% o f C re d it C a rd s
60%
r a te
32.5%
40%
20%
0% 25.0%
[0%-5%) [5%-10%) [10%-20%) [20%-30%) [30%-40%) [40%-50%) [50%-100%]
Ex ante probability of default
Bank 1 0.232
Bank 2 0.137
Bank 3 0.010
Bank 4 0.575
Bank 5 0.011
Bank 6 0.045
Bank 7 0.001
Bank 8 0.041
Bank 9 0.125
Bank 10 –0.053
100% 52%
60%
36%
40%
20%
0% 20%
[0%-10%) [10%-20%) [20%-40%) [40%-60%) [60%-80%) [80%-100%] >100%
Percentage of Payment
Graph 15
Client indebtedness risk price differentiation
across the system
100% 52.00%
Spread over interbank rate
80%
% of Credit Cards
60%
36.00%
40%
20%
0% 20.00%
[0%-10%) [10%-20%) [20%-40%) [40%-60%) [60%-80%) [80%-100%] >100%
Credit Limit Use
Wald Confidence
Explanatory variables Coefficient
Level (95%)
Wald Confidence
Explanatory variables Coefficient
Level (95%)
Wald Confidence
Explanatory variables Coefficient
Level (95%)
20.0%
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
200604 200605 200606 200607 200608 200609 200610 200611 200612 200701 200702 200703
Graph 17
March 2007 point in time PD estimation
20.0%
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
200604 200605 200606 200607 200608 200609 200610 200611 200612 200701 200702 200703
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
200604 200605 200606 200607 200608 200609 200610 200611 200612 200701 200702 200703
6. Conclusions
The diagnosis of systemic risk exposure has never been more
important in the international regulatory agenda to protect
financial systems from destabilizing events. There exists today
important efforts to address this risk and the present document
intends to add to this line of work.
Account Performance
t 0
PT (i, t ) PA(i, t )
t 2
t 0
SP (i, t )
t 2
45
46
PGE_TOTALPAY_3M Percentage of periods in which the borrower has paid all (or
more) of their balance within the last three months (also
built for 6, 9 and 12).
t 0
SI PA(i,t ) PT (i,t ) SP(i,t )
t 2
3
t 0 PT (i , t ) PT (i , t 1)
FSI Award – 2010 Winning Paper
IF
t 11 SP(i , t ) SP(i , t 1)
PM (i ,0)
SP (i ,0)
FSI Award – 2010 Winning Paper
t 0 PM(i, t ) PM(i, t 1)
IF
t 11 SP(i, t ) SP(i, t 1)
47
48
t 0
PT (i , t ) PA(i , t ) PM (i , t ) y
IF PT (i ,t 1) PA(i,t 1) PM (i,t 1)
t 2
FSI Award – 2010 Winning Paper
t 0
PT ( i , t ) PA( i , t ) PM ( i , t ) y
IF
t 11 PT ( i , t 1) PA ( i , t 1) PM ( i , t 1)
NONPAY_HIS: Historical Non- Number of periods in which the cardholder has not covered
Payment (HIS) the minimum payment in the last six months.
t 0
IF PT (i,t ) PA(i, t ) PM (i, t )
t 5
t 0
IF PT (i, t ) PA(i,t ) PM (i, t )
t 11
49
50
t 0
IF ( NONPAY _ SA _ T
t 11
t NONPAY _ SA _ Tt 1 )
t 11 PT ( i , t 1) PA ( i , t 1) PM ( i , t 1)
FSI Award – 2010 Winning Paper
TIMES2NONPAY Number of times that the borrower did not make the
minimum payment on two consecutive periods in the past
12 months.
USE_LINE_T0: Credit Limit Use Total outstanding balance as a proportion of the credit limit
at the reference point.
SP (i , t )
LC(i , t )
51
52
AVRGE_USELINE_3M Average of the Credit Limit Use during the last three
months (also built for 6, 9 and 12 months).
t 0
SP(i, t )
t 2
3
t 0
LC(i, t )
t 2
3
MAX_USELINE_3M Maximum Credit Limit Use in the last three months (also
FSI Award – 2010 Winning Paper
SP(i, t ) t 0
max
LC(i, t ) t 2
FSI Award – 2010 Winning Paper
t 0
IF (SP(i, t ) LC(i, t ))
t 2
3
53
54
SP (i , t 0)
max SP (i , t ) t 2
t 0
NUM_MAXBALANCE_6M Number of times that the balance was equal to the credit
limit in the last six months.
FSI Award – 2010 Winning Paper
t 0
IF (SP (i, t ) LC(i, t ))
t 5
FSI Award – 2010 Winning Paper
SP ( i , t 0)
t 1
SP (i , t )
t 6
6
t 0
SP (i , t )
t 2
3
t 3
SP (i, t )
t 5
3
55
56
t 0
IF (LC(i, t ) LC(i, t 1))
t 2
t 0
IF (LC(i, t ) LC (i, t 1))
t 2
FSI Award – 2010 Winning Paper
t 0
LC(i, t ) LC(i , t 1)
t 11
FSI Award – 2010 Winning Paper
t 0
LC(i, t ) LC(i, t 1)
t 11
PM (i ,0)
ln
TI (i ,0)
PM (i ,0) * SP (i ,0)
12
TI (i ,0)
ln1
12
57
58
PT (i ,0)
ln
TI (i ,0)
PT (i ,0) * SP (i ,0)
12
TI (i ,0)
ln1
12
FSI Award – 2010 Winning Paper
FSI Award – 2010 Winning Paper
AGE_T0: MATURITY Number of months elapsed since the opening of the credit
card in the bank.
T0 CC Open Date
t 0
H (i , t )
t 12
59
60
t 0
R( i , t )
t 12
t 0
H ( i , t ) R( i , t )
t 12
t 0
H (i , t )
t 0
FSI Award – 2010 Winning Paper
t 0
AH(i,t )
t 12
t 0
AH (i, t ) AR(i, t )
t 12
61
62
t 0
CH(i,t )
t 12
t 0
CR(i,t )
FSI Award – 2010 Winning Paper
t 12
t 0
CH(i,t ) CR(i,t )
t 12
FSI Award – 2010 Winning Paper
Employment Behaviour
SM (t 0 )
t 0
SM (i , t )
t 5
6
FSI Award – 2010 Winning Paper
DAYS_PER_T0 Number of days that the borrower worked in the last two-
month period since the reference point.
DC (t 0)
FSI Award – 2010 Winning Paper
AVG_DAYS_6M Average over the last six months of the number of days
the borrower worked in a two-month period.
t 0
DC(i, t )
t 5
6
65
Annex 2:
Reserve requirement rule
Where:
Ri = Amount of reserves of the ith credit.
PDi = Probability of default of the ith credit.
LGDi = Loss given default of the ith credit
EADi = Exposure at default of the ith credit.
Probability of Default
If ACT < 4 then
PDi =
1
2.9704 0.6730 ACT 0.4696 HIS 0.0075 MAT 1.0217 %PAY 1.1513 %USE
1 e
Exposure at Default
0.5784
Bal t 0
EADi Bal t 0 * Max , 100%
CrLimit t 0