Credit Risk Excellence in the Basel II Framework

Stefano Romano – Head of Credit and Operational Risk Area and Partner at Prometeia

The long journey has just begun. This is what emerged from the one-day conference organized in Istanbul by Prometeia and the Turkish Risk Managers Association, which managed to bring all the representatives of the credit risk management industry together -  from domestic and international regulators to the most prominent banks in Turkey.

In the wake of the Basel II framework, Turkish banks are beginning their transition from standardized to Internal Ratings Based (IRB) approach models for credit risk management, with an eye on the new guidelines the European Banking Authority. Alongside the main panels, Prometeia also  made its expertise available in workshops dedicated to the hottest topics in the Turkish banking scene, from credit risk modelling and validation to stress test and, of course, IFRS 9 solutions, giving regulators and practitioners the chance to exchange their  views and experiences in person.

The Turkish banking system at a glance

The Turkish banking system has been growing rapidly in recent years. Total assets and loans to customers have been quickly increasing while capital ratios have declined, elevating effective capital management as one of the most important issues. Banks now have high levels of RWAs, with credit risk component accounting for 90 per cent of the total. All of them are still using standardized models instead of IRB models. A gradual switch to the latter framework will benefit them through the improvement of their risk pricing (and re-pricing) activities, risk adjusted performance measurements and credit portfolio strategies, while allowing them to enjoy capital requirements from regulatory bodies better fit to their risk profile.

“One application to transition to IRB models has been received and we expect others to follow shortly” says Ehran Ҫetinkaya, Head of Risk Department at the domestic Banking Regulation and Supervision Agency. Such new regulation for Turkish banks is now in place, requiring three years for testing the use of the new models. The regulatory body is collecting all the historical internal data, even though “banks should not underestimate self-assessment activities, which are to be prepared carefully” warns Mr Ҫetinkaya, who promises severe scrutiny in this critical phase. Most of the Turkish managers attending the conference expect the regulator to be stricter in the transitional arrangements, increasing coverage requirements.

The perspective of regulators

“The main issue for banks is to grow an understanding of a risk sensitive approach,” says Susanne Roehrig, Senior Policy Expert at European Banking Authority, which will set benchmark guidelines that will be one of the main references for the Turkish regulator. Why put so much effort in defining IRB models if the entire Basel framework is under review? “The Basel Committee for Banking Supervision is reducing the scope of eligibility for IRB approach, but within this new scope there are going to be the same PD and LGD models, aimed at reducing unjustified variability in capital requirements among banks” continues Mrs Roehrig.  She suggests Turkish banks should start with focusing on the portfolios already supported by reliable and high quality databases, a vital condition to produce internal ratings.

A new era for the Turkish banking system

All major banks say they have been considering the transition to IRB-compliant models since the beginning. In their view, the process has already been a success helping them improve the integration among business units as well as IT, HR and training departments. So far so good? If expectations are pretty high, so is caution. A risk model takes months to be developed; in the meanwhile, regulation may change. However, all of the Turkish risk managers convened at the event agree upon one thing: the use of internal models will help strengthen financial stability and transparency and benefit the overall economy by lowering capital ratio requirements, regardless of the ongoing discussions about turning the Advanced IRB approach into a more consistent framework.