Assessing Validity of the Basel Ii Model in Measuring Risk of Credit Portfolios

Abstract

The paper assesses validity of credit loss distributions of client portfolios calculated by means of the Basel II model. The assessment method consists in parallel calculations the same distributions by means of exact probabilistic formulae. We found that Basel II model ensures correct assessments of credit loss distributions for medium and large portfolios of thirty or more one-period credits (credits without intermediate interest etc. payments). For small portfolios and individual one-period credits assessments of Basel II model are rough or extremely rough. Basel II model undervalues credit risk of portfolios of multi-period credits (credits with active period covering several years and intermediate payments). Exact models are more complex that Base ll model, but perfectly available for quick computer calculations. They can be used in bank practice ensuring flexible assessments of credit risk.

Keywords: Credit risk, credit loss distribution, Basel II, model validation and calibration

JEL Classification: C51, C52, E51, E58, F33, G21