Bogie Ozdemir, Senior Director Risk Solutions WDC Feb, 2008 The Role of External Ratings Under Basel II 2. Agenda ? External Ratings can play important roles in IRRs design, quantification and validation – but we need to be careful about the appropriate usage. ? External Ratings can be used in 1. Risk Rating Assignment § Utilizing the Ratings § Utilizing the Methodology 2. Risk Rating Quantification 3. Validation § Benchmarking § Becktesting 3. Use of the External Ratings in Risk Rating Assignment ? Agency Ratings are used as inputs to the Risk Rating Assignment process along with PDs/EDFs from quantitative models, Financial rations and Qualitative Factors ? Pro: All available information is utilized BUT.. ? Con: Double counting: Financial Ratios and Qualitative Factors are already utilized in External Ratings. Financial Ratios may also be utilized in quantitative PDs/EDFs. Determine Risk Rating Agency Ratings Quantitative PD model Financial Ratios Qualitative Factors Risk Rating to PD Mapping PD Example Risk Rating and PD assessment process 4. Use of the External Ratings in Risk Rating Assignment ? Con - Consistency Issues: Philosophical Differences; Quantitative PDs/EDFs are more PIT than External Ratings. ? We don ’ t have External Ratings and Quantitative PDs/EDFs for all obligors. Based on where we are in the cycle and whether or not we have External Ratings and Quantitative PDs/EDFs, the ratings of similar obligors can be inconsistent ? Utilizing rating methodology instead of the ratings for LDPs? Determine Risk Rating Agency Rati ngs More TTC Quantitative PD model More PIT Financial Ratios Maybe PIT but lagging Qualitative Factors Intended to be PIT but not frequently updated Risk Rating to (Risk Rating) PD Mapping PD assigned to the Risk Rating Long-run Unconditional PD assi gned to the Obl i gor ? More PIT (frequent re- grading or otherwise) ? More TTC (no re- grading or otherwise based on systematic factors) 5. Use of the E
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