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seamless and swifter customer experience. For this, below is the Credit Risk Model Framework which IDBI needs
to follow in order to shift to analytical approach.
The board member & the management need to evaluate and preparation of the risk assessment. Questions like
strategic direction of the portfolio, budget and growth expectations, changes in products or processes and the
risks brought on by those changes, etc need to be answered in order to finalize the business, theory &
development phase. The past data (training data) is used as input in model, which after processing gives an
output. In the data validation stage, the estimated output of the model is compared with the actual output to
check whether the model accuracy. Model Risk is something that is eliminated by this step.
Since we are suggesting the bank to develop a retail face, we would be suggested them to go ahead with the
consumer credit models to understand the customer trend and also develop tailor made products for the
customer’s needs.
After the model has been decided, the management need to implement the correct strategy. Also, with
digitalization, it is important to test the adherence of the to & enforcement of policies & procedures.
Understanding the limit of the bank in terms of its risk appetite and after all the approvals, the data (testing data)
is provided as the input. The input to, for example, behavioral model would consider the 5 Cs which are:
Character
Capital
Collateral
Capacity
Condition
Data can be from a 3rd party vendor as it will be a challenge faced by the bank in the initial stages. It needs to be
aggregated and the stratified to improve the data quality. The assumptions also play a very important role as they
decide the bank’s behavior as well the client’s behavior at pool level. The output is put to scrutiny under the risk
management department. The model is constantly re-evaluated to maintain the accuracy. This is done through
constant stress testing, benchmarking & sensitivity analysis. If any change is required, the management needs to
be reported in order to take the necessary decisions to re-strategize.
Business
Need
Theory
Development Calibration
Yes?
Production
Calibration
A vast amount of work is done for the automatic estimation of PD using machine learning methods and then
modelling PD aiming to predict defaulted and non-defaulted loans. However, this credit risk parameter is
insufficient to assess the loans' overall credit risk, as defaulted loans lead to different economic losses for the
lending institution. Therefore, modelling LGD and EAD hold particular interest for credit market participants, as
these parameters are used respectively to calculate capital requirements and risk- weighted assets. We thus,
integrated the two & suggest this 2-stage consumer credit risk modelling.
The first stage involves traditional PD modelling using classifier ensembles to distinguish between two classes of
loans, namely defaulted (with EL > 0) and non-defaulted (EL = 0) loans. Related studies have shown that imbalance
in the class distribution of loans significantly decreases performance on the minority class of defaulted loans.
Since IDBI bank’s loan portfolio is skewed towards corporate loans that too in the steel and power sectors, under-
sampling is done to the majority class (corporate loans) of non-defaulted loans. This training data (past data) is
given as an input to the ensemble which a machine learning algorithm that can be trained and thus used in
predictive modelling in order to decrease variance and bias thus, improving the accuracy.
The loans identified as potentially defaulting enter the second stage, which estimates the EAD of these loans using
a regression ensemble. Finally, the two prediction models (PD and EAD) are combined to predict the overall EL.
This approach not only outperforms and is also more accurate than PD and EAD models used separately.
Using this approach, the bank can move from its current standard approach for credit risk to using advanced- IRB.
This will help IDBI bank in coming out as a strong bank and improve its image