comparison of credit risk models for portfolios of retail.docVIP

Comparison of credit risk models for portfolios of retail loans based on behavioural scores. Lyn C Thomas, University of Southampton Madhur Malik, Lloyds Banking Group Abstract The fact that the Basel Accord formula is based on a corporate credit risk model and the mis-rating of mortgage backed securities which led to the credit crunch have highlighted that developing credit risk models for portfolios of retail loans is far less advanced than the equivalent modelling for portfolios of corporate loans. Yet for more three decades behavioural scoring has proved a very successful way of estimating the credit risk of individual consumer loans. Almost all lenders produce a behavioural score for every one of their loans every month. This paper reviews the different models that are being developed to use these individual behavioural scores to assess the credit risk at a portfolio level. The models have parallels with the types of corporate credit risk models, but differ because of the need to deal with the features specific to retail loans such as the months on books effect. Thus there are structural type models, ones based on hazard rates and ones that use Markov chain stochastic approaches. Keywords Behavioural scoring, credit risk, portfolios of consumer loans, default probabilities, reputational effects, proportional hazard models, Markov chains Introduction Modelling the credit risk of portfolios of consumer loans has attracted far less attention than modelling the corporate equivalent. This was first apparent when the Basel II Accord formula for the minimum capital requirement (Basel Committee on Banking Supervision 2005), which was based on a version of the Merton-Vasicek model of corporate credit risk, was applied to all types of loans, including consumer loans. The parameters for the consumer loan regulations were chosen empirically to produce appropriate capital levels. Another example of the lack of research into modelling the credit risk of portfolios of cons