Issues in the Credit Risk Modeling of Retail Markets

48 Pages Posted: 3 Nov 2008

See all articles by Linda Allen

Linda Allen

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Gayle L. DeLong

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Multiple version iconThere are 4 versions of this paper

Date Written: February 2003

Abstract

Retail loan markets create special challenges for credit risk assessment. Borrowers tend to be informationally opaque and borrow relatively infrequently. Retail loans are illiquid and do not trade in secondary markets. For these reasons, historical credit databases are usually not availablefor retail loans. Moreover, even when data are available, retail loan values are small in absolute terms and therefore application of sophisticated modeling is usually not cost effective on an individual loan-by-loan basis. These features of retail lending have led to the development of techniques that rely on portfolio aggregation in order to measure retail credit risk exposure. BISproposals for the Basel New Capital Accord differentiate portfolios of mortgage loans from revolving credit loan portfolios from other retail loan portfolios in assessing the bank s minimum capital requirement. We survey the most recent BIS proposals for the credit risk measurement of retail credits in capital regulations. We also describe the recent trend away from relationship lending toward transactional lending, even in the small business loan arena traditionallycharacterized by small banks extending relationship loans to small businesses. These trends create the opportunity to adopt more analytical, data-based approaches to credit risk measurement. We survey proprietary credit scoring models (such as Fair, Isaac and SMEloan), as well as options-theoretic structural models (such as KMV and Moody s RiskCalc) and reduced form models (such as Credit Risk Plus).

Suggested Citation

Allen, Linda and DeLong, Gayle L., Issues in the Credit Risk Modeling of Retail Markets (February 2003). NYU Working Paper No. FIN-03-007, Available at SSRN: https://ssrn.com/abstract=1294581

Linda Allen

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States
646-312-3463 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://stern.nyu.edu/~lallen

Gayle L. DeLong

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

One Bernard Baruch Way
Box B 10-225
New York, NY 10010
United States
646-312-3493 (Phone)
646-312-3451 (Fax)

HOME PAGE: http://faculty.baruch.cuny.edu/gdelong

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