Forecasting and Stress Testing

  • Basel II
  • Data Analysis
  • Provision Models
  • Credit Risk Models
  • Forecasting. Stress Testing

Portfolio Stress Testing

Part of the requirements of the Basel II framework will be that capital requirements are stress tested, that is, assessed under alternative macro-economic outlooks and competitive environments. The critical requirements for this analysis are to understand how the portfolio will react to a changing environment; there are two main possibilities both of which will have an effect:

  1. The distribution of customer types will change
  2. The behaviour of customers of the same type will change

Unlike many other approaches to this problem 4-Most offers a “bottom up” approach based on sophisticated simulation and modelling techniques. This approach is preferred because it fully exploits the large volumes of consumer level information available and it is extremely flexible. The simulation model is used to aggregate predictions about individuals in order to understand the likely performance and capital requirements of the whole portfolio.

Forecasting

4-Most consultants have a strong background in modelling dynamic systems – in particular, the modelling, forecasting and stress testing elements of portfolio management which encompass the Basel framework.

This is an area of increasing importance as the new Basel III accord is due to be phased in over the coming years. Basel III, with its demand for higher Tier 1 Capital ratios, will highlight the way banks address the integration of risk management and finance functions and requires careful capital planning and balance sheet management.

4-Most consultants have considerable experience in this area, having previously built and implemented a number of models at major Retail banks.

These include:

  • Forecasting Internal Ratings Based (IRB) RWA for Basel II
  • Continuous scorecards – Loss Given Default (LGD) prediction
  • Probability of Default (PD) – using behavioural scores flexed with evolving macro-economic factors
  • Loss Forecasting – Roll rates, discounted cash flows and macro-economic factor models.

Recent projects undertaken by 4-Most consultants on behalf of clients have used these techniques, for example, the re-deployment of mortgage forecasting models to predict provision for a European retail bank, after a significant change in assumptions and macroeconomic factors.