Issues in the Credit Risk Modeling of Retail Markets
48 Pages Posted: 3 Nov 2008
Date Written: February 2003
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).
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