Irrespective of whether a bank is using external, internal, or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used must be at least five years for at least one source. If the available observation period spans a longer period for any source, and this data is relevant and material, this longer period must be used.
Irrespective of whether banks are using external, internal, pooled data sources, or a combination of the three, for their estimation of loss characteristics, the length of the underlying historical observation period used must be at least five years.
If the available observation spans a longer period for any source, and these data are relevant, this longer period must be used. A bank need not give equal importance to historic data if it can convince its supervisor that more recent data are a better predictor of loss rates.
The SAMA applies the transitional requirement of a minimum of two years of data at the time of adopting the Foundation IRB Approach for corporate, sovereign, and bank exposures or the IRB Approach for retail exposures.
Corporate, sovereign, and bank exposures
4.4.3
Bank should use information and techniques that take appropriate account of the long run experience when estimating the average PD for each rating grade. For example, banks may use one or more of the three specific techniques set out below (i.e. internal default experience, mapping to external data, and statistical default models),
4.4.4
Banks may have a primary technique and use others as a point of comparison and potential adjustment. SAMA will not be satisfied by mechanical application of a technique without supporting analysis. Banks should recognize the importance of judgmental considerations in combining results of techniques and in making adjustments for limitations of techniques and information.
4.4.5
Banks may use data on internal default experience for the estimation of PD. They should demonstrate in their analysis that the estimates are reflective of actual default experience and of any differences in the rating system that generated the data and the current rating system. Where only limited data are available, or where underwriting standards or rating systems have changed, Banks should add a greater margin of conservatism in their estimate of PD. The use of pooled data across banks may also be recognized. A bank should demonstrate that the internal rating systems and criteria of other bank in the pool are comparable with its own.
4.4.6
Banks may associate or map their internal grades to the scale used by an external credit assessment institution (“ECAI”) and then attribute the default rate observed for the ECAI’s grades to the bank’s grades. Mappings should be based on a robust comparison of internal rating criteria to the criteria used by the ECAI and on a comparison of the internal and external ratings of any common borrowers. Biases or inconsistencies in the mapping approach or underlying data should be avoided.
4.4.7
The ECAI’s criteria underlying the data used for quantification should be oriented to the risk of the borrower and not reflect transaction characteristics. A bank’s analysis should include a comparison of the default definitions used, subject to the requirements in subsection 4.2 above. The bank should document the basis for the mapping.
4.4.8
Banks that aggregate the PD of individual portfolio obligors when calculating PD estimates for internal grades should have a clear policy governing the aggregation process. A mean of PD estimates for individual borrowers in a given grade should be used. A bank would only be allowed to calculate this estimate differently if it can demonstrate that the alternative method provides a better estimate of the long run average PD. To obtain this evidence, the bank should at least compare the results of both methods.
4.4.9
Banks’ use of default probability models for estimating PD should meet the standards specified in subsection 4.6 of the “Minimum Requirements for Internal Rating Systems under IRB Approach”.
Retail exposures
4.4.10
Given the bank specific basis of assigning exposures to pools, banks should regard internal data as the primary source of information for estimating loss characteristics. Banks are permitted to use external data or statistical models for quantification provided a strong link can be demonstrated between:(i) the bank’s process of assigning exposures to a pool and the process used by the external data source; and (ii) the bank’s internal risk profile and the composition of the external data. In all cases banks should use all relevant and material data sources as points of comparison.
4.4.11
One method for deriving long run average estimates of PD and default-weighted average loss rates given default (as defined in 4.5.1) for retail would be based on an estimate of the expected long run loss rate. A bank may (i) use an appropriate PD estimate to infer the long run default-weighted average loss given default; or (ii) use a long run default-weighted average loss rate given default to infer the appropriate PD. In either case, it is important to recognize that the LGD used for the IRB capital calculation cannot be less than the long run default-weighted average loss rate given default and should be consistent with the concept defined in paragraph 4.5.1.
4.4.12
Seasoning can be quite material for some long-term retail exposures characterized by seasoning effects that peak several years after origination. Banks should anticipate the implications of rapid exposure growth and take steps to ensure that their estimation techniques are accurate, and that their current capital level and earnings and funding prospects are adequate to cover their future capital needs.
4.4.13
In order to avoid gyrations in their required capital positions arising from short-term PD horizons, banks are also encouraged to adjust PD estimates upward for anticipated seasoning effects, provided such adjustments are applied in a consistent fashion over time.
4.4.14
If a bank does not take seasoning effects into account and its own estimates of PD are considered to be too low, SAMA may require banks to use higher values of PD for the calculation of capital charges. PD’s will be considered too low if validation tests, stress tests, back testing indicates lack of predictability,
