Systemic estimation of PD, LGD and EAD for credit card as a reserve requirement and validation method.

Mexican Experience

Mexican Banking System

The Mexican banking system is concentrated in 7 banks that accumulate 87% of the total loan portfolio and are mainly foreign owned (US, Spain, UK, Canada).
Balance sheet (Billions MXN) Loan Portfolio Deposits

ROE (12m) (%) Jul-11 12.53 20.65 8.97 14.59 15.77 8.48 1.41 10.20 Aug-11 12.32 19.95 8.53 14.23 15.61 8.21 1.64 10.04

Capital Ratio (%) Jul-11 16.39 15.58 17.04 15.94 14.81 24.82 14.27 16.60 Aug-11 16.21 15.51 16.90 15.67 14.24 23.21 14.78 16.43

Jul-11
Banking System BBVA Bancomer Banamex Banorte Santander Inbursa HSBC Scotiabank

Aug-11 2,298 588 359 275 301 155 184 115

Jul-11 2,510 620 447 288 316 123 279 121

Aug-11 2,542 634 446 282 338 120 281 121

2,271 581 359 271 297 153 182 114

Mexican Banking System

However the rate of deterioration of the credit card portfolio showed a significant increase in 2009. 11%
Delinquency Index (Past Due Loans / Total Balance) of consumer loans portfolio 10% 9% 8% 7% 6% 5% 4%3.2% 3% 2%2.7% 1% 1.4% 0% Jan-05 Jan-06 9.8% Credit Cards 6.6% 4.5%

Other** Consumer Credit

125,000 100,000 75,000 50,000 25,000

Loan loss provision Annual Cash Flow

5.0 4.0 3.0 2.0 1.0

Jan-07

Jan-08

Jan-09

0.0 0 mar-06 sep-06 mar-07 sep-07 mar-08 sep-08 mar-09 Mortgage Consumer Credit Corporate Credit

** Includes Personal credit, leases, and other consumer credits

Mexican Banking System

Consumer credit loan portfolio deteriorarion had an important impact on banks profitability.
12 months / productive assets

Phase 1
14% 12% 10% 8% 6% 4% 2% 0%

Phase 2

Phase 3
1.1% Sep-09

Net profit

Financial margin + commissions

2.5% Dic-04

Loan loss provisions

Operational expenses
Dic-06 Jun-05 Jun-08 Jun-07 Dic-08 Dic-04 Dic-05 Dic-07 Jun-06 Jun-09

Mexican Banking System

This deterioration was mostly explained by a systemic increase in household indebtedness
Credits per Person by Credit Type 4.4 4.2 4 3.8 1.20 3.6 1.15 3.4 3.2 3 D J F MA M J J A S ON D J F MA M J J A S ON 2005 2006 2007 Mortgage (right axis) Car (right axis)
300,000

1.40 1.35

MXN pesos
900,000 800,000

Monthly Average Debt-Capacity per Debtor (Sample) Number of debtors (right axis)

1.30 700,000 1.25 600,000

500,000 400,000

1.10

Available Credit

200,000 Limit (left axis)

1.05 100,000 1.00

0 1 2 3 4 5 6 7 8

Number of Credit Cards Dec. 2005 Nov 2007

Bank credit cards (left axis) Source: Credit bureau

G20 and Basel recommendations on loan loss provisions

In April 2009 the G20 issued recommendations on financial supervision and regulation that led the Basel committee to propose the following recommendations related to loan loss provisions: 1. Loan loss provisioning should be robust and based on sound methodologies that reflect expected credit losses in the banks existing loan portfolio over the life of the portfolio. The accounting model for provisioning should allow early identification and recognition of losses by incorporating a broader range of available credit information than presently included in the incurred loss model. The new standard should utilize approaches that draw from relevant information in banks internal risk management and capital adequacy systems

2.

3.

IASB and Basel recommendations on loan loss provisions

Recommendations were sent to IASB in order to promote the necessary coordination between standard setters, supervisors and regulators on their respective efforts to implement the G20 recommendations. Consequently IASB issued in November 2009 a proposal to modify loan loss provisions accounting. Incurred loss model (current IASB standard)
Assumes that loans will be paid until evidence on the contrary is identified (loss event). The financial crisis has evidenced that these models are characterized by evaluating optimistically the loan portfolio and are suddenly followed by large credit losses.

Expected loss models (proposal adopted by Basel and IASB)

Losses are estimated on a forward looking basis according to the quality of the portfolios. It implies an approximation of the PD, LGD and EAD.

Content
1. 2. 3. 4. Introduction Systemic estimation of PD, LGD and EAD Risk Analysis of the Credit Card Loans Portfolio Conclusions

Incurred Losses
Until August 2009, Mexico had an incurred loss type regulatory provisioning model. Provisions were created by applying fixed percentages to loans in different levels of delinquency.
Number of delinquent periods 0 1 2 3 4 5 6 7 8 9 or more % of Provisions 2.5% 19% 48% 58% 62% 85% 95% 100% 100% 100%

Incurred Losses
12 month write offs were significantly higher than the balance of loan loss provisions revealed on banks balance sheets. Write offs (next 12 months) / loan loss provision balance
12 M ES ES

Q y C /C V

800%

600%

400%

200%

0% E n e -0 6

Jan-06

A g o -0 6

A b r-0 7

D i c -0 7

A g o -0 8

Credit card overall portfolio

1 Write

Offs in the following 12 months,.

Incurred Losses
Some disadvantages of the Incurred Loss Model are: Loans are provisioned when factual evidence is available that a loan or portfolio of loans will not be repaid in full. (Late recognition of losses) Generate provisions for no concrete time horizon. Show pro-cyclicality since they generate largest amount of provisions when there is evidence that loans will not be repaid.

Incurred Losses
Some disadvantages of the Incurred Loss Model are (continued): Do not generate provisions for loans with no delinquency even though these loans have a positive expected loss. They do not consider the potential growth of the exposure at the time of default (relevant feature in revolving credit). Similar financial assets in different entities may generate loss coverage for different periods of time.

Expected Losses
Internal Models are characterized for estimating the components of the expected loss. Expected losses standardize the time horizon and the default definition for all institutions. Expected Loss = PD * LGD * EAD Where: PD = Probability of default LGD= Loss given default EAD = Exposure at default

PD estimation
A window of 25 months was established to carry out the analysis of the behavior "profile" of each credit card. Historical Period (T-12, T0). Performance Period (T0, T12) Reference Point = T0
t = -12 t=0 t = +12

Historical Period

Performance Period

PD estimation
t = -12 t=0 t = +12

Performance Period

Default is declared when a borrower attains a past due status on his payment obligations of 90 days.

Sample for analysis

A sample of loan-level data representing 97.3% of total credit card loans in the system was extracted from banks.
# Contratos Inbursa AMEX Banorte Santander Banamex BBVA Bancomer\Finanzia GE Money Invex Scotiabank HSBC Otros TOTAL 712,034 1,025,869 1,256,316 3,448,425 8,971,960 13,999,809 796,019 853,343 790,995 2,201,229 946,902 35,002,901 % Sistema 2.03% 2.93% 3.59% 9.85% 25.63% 40.00% 2.27% 2.44% 2.26% 6.29% 2.71% 100.00% Informacin Recabada 712,034 1,025,869 1,256,316 3,448,425 8,971,960 13,999,809 796,019 853,343 790,995 2,201,229 34,055,999 % Informacin Recabada 2.03% 2.93% 3.59% 9.85% 25.63% 40.00% 2.27% 2.44% 2.26% 6.29% 97.29% % Sistema Ajustado 2.09% 3.01% 3.69% 10.13% 26.34% 41.11% 2.34% 2.51% 2.32% 6.46% 100.00%

The sample allowed a maximum error of 40 basis points on a PD estimation with (1- ) = 99% confidence.

P( p p d ) > 1

Database
Data were organized in 12 windows of information spanning 25 months of payment history.
May 06 Aug 06 May 05 Nov 06 May 07 Sep 06 Dec 06 Nov 05 Aug 07 Sep 07 Nov 07 Aug 05 Sep 05 Feb 07 Jun 06 Dec 05 Mar 07 Dec 07 Mar 06 Feb 06 Jan 07 Feb 08
12 11 12

Apr 06

WINDOW 1 2 3 4 5 6 7 8 9 10 11 12

FROM

TO

Apr 05 May 05 Jun 05 Jul 05 Aug 05 Sep 05 Oct 05 Nov 05 Dec 05 Jan 06 Feb 06 Mar 06

Apr 07 May 07 Jun 07 Jul 07 Aug 07 Sep 07 Oct 07 Nov 07 Dec 07 Jan 08 Feb 08 Mar 08

-12 -11 -10

-9

-8 -9

-7 -8 -9

-6 -7 -8 -9

-5 -6 -7 -8 -9

-4 -5 -6 -7 -8 -9

-3 -4 -5 -6 -7 -8 -9

-2 -3 -4 -5 -6 -7 -8 -9

-1 -2 -3 -4 -5 -6 -7 -8 -9

0 -1 -2 -3 -4 -5 -6 -7 -8 -9

1 0 -1 -2 -3 -4 -5 -6 -7 -8 -9

2 1 0 -1 -2 -3 -4 -5 -6 -7 -8 -9

3 2 1 0 -1 -2 -3 -4 -5 -6 -7 -8

4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7

5 4 3 2 1 0 -1 -2 -3 -4 -5 -6

6 5 4 3 2 1 0 -1 -2 -3 -4 -5

7 6 5 4 3 2 1 0 -1 -2 -3 -4

8 7 6 5 4 3 2 1 0 -1 -2 -3

9 8 7 6 5 4 3 2 1 0 -1 -2

10 9 8 7 6 5 4 3 2 1 0 -1

11 10 9 8 7 6 5 4 3 2 1 0

12 11 10 9 8 7 6 5 4 3 2 1 12 11 10 9 8 7 6 5 4 3 2 12 11 10 9 8 7 6 5 4 3 12 11 10 9 8 7 6 5 4 12 11 10 9 8 7 6 5 12 11 10 9 8 7 6 12 11 10 9 8 7 12 11 10 9 8 12 11 10 9 12 11 10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

-12 -11 -10

Mar 08

Oct 06

Jun 05

Jan 05

Jun 07

Jan 08

Apr 07

Apr 05

Oct 05

Oct 07

Jul 06

Jul 05

Jul 07

Database
Three sources of information were used for the analysis. t = -12 t=0 t = +12

DATABASE 1 Bank Information

DATABASE 2 Credit Bureau Information

DATABASE 3 Social security Information

PD

t = -12

t=0

t = +12

Product Policy

Borrower Behavior

Credit Bureau

Social security information

10 Variables
Examples: - Minimum payment amount of the last 12 months. -Maximum credit limit in the last 12 months. -Theoretical time that will take to repay the balance according to the minimum payment and the interest rate of the product.

46 Variables
Examles: - Average use of the credit limit in the last 12 months. -Percentage of payment over the balance. - Number of times that the borrower paid the total balance. - Number of non-payments in the credit card.

9 Variables
Examples: - Number of credit opened in the period. cards

10 Variables
Examples: -The borrower has formal or informal employment - The borrower has a mortgage with the Social Housing institute (INFONAVIT) - Borrowers Income at the reference point (measured in minimum wage).

- Record of payment in other open accounts - Number of credits that the borrower has at the reference point.

PD
For the estimation of the systemic PD standard logistic regression was used to correlate the historical period constructed variables with the observation period binary event of default.

( x1 ,..., xn ) =

1 1+ e
0 + 1 x1 +...+ n xn ) (

Percentage of payment
Amount of payment made by the cardholder as a proportion of the outstanding balance at the reference point.
Credit Card Portfolio
100% 80% Frecuency 60% 30.0% 40% 20.0% 20% 0% 10.0% 20% 30% 50% 60% 80% 10% 40% 70% 90% 100% 110% 0% 0.0% 60.0% 50.0% 40.0% % Default
% PMT (T0) % default

Interval 0% 10% 20% 30% 40%

PD 26.00% 20.94% 16.65% 13.10% 10.21% 7.90% 6.07% 4.65% 3.55% 2.70% 2.05% 1.55%

Ave Std Dev Max Q75 Median Q25 Min

0.3695 0.4051 1.1000 0.7109 0.1464 0.0557 0.0000

50% 60% 70% 80% 90% 100% 110%

%PMT (T0)

Pmt = Payment Bal = Balance

% PMT (T0 ) =

PmtT0 BalT0

Credit Limit Consumption

Outstanding balance of the credit card as a percentage of the credit limit offered by the bank to the client.
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 40% 20% 0% 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 20% 30% 50% 60% 70% 90% 100% 10% 40% 80% 250% 0% 0.0% % Default
% USE (T0) % default

Interval 0% 10% 20% 30% 40%

PD 5.67% 6.75% 8.02% 9.51% 11.24% 13.24% 15.53% 18.13% 21.06% 24.33% 27.92% 86.38%

Ave Std Dev Max Q75 Median Q25 Min

0.4851 0.3976 2.5000 0.8657 0.4124 0.0984 0.0000

50% 60% 70% 80% 90% 100% 250%

% USE (T0)

Bal = Balance

%USE (T 0) =

BalT0 Credit LimitT0

Current Non-Payment (ACT)

Consecutive periods, in which the cardholder has not covered the payment obligation.
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 40% 20% 0% 90.0% 80.0% 70.0% 60.0% % Default 50.0% 40.0% 30.0% 20.0% 10.0% 0 1 2 3 0.0%
ACT % Default

Interval 0 1 2 3

PD 9.24% 30.49% 65.39% 89.06%

Ave Std Dev Max Q75 Median Q25 Min

0.2386 0.6219 3.0000 0.0000 0.0000 0.0000 0.0000

ACT

Historical Non-Payment (HIS)

Number of periods in which the cardholder has not covered the minimum payment in the last 6 months.
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 60.0% 40% 40.0% 20% 0% 20.0% 4 0 1 2 3 5 6 0.0% 120.0% 100.0% 80.0% % Default
HIS % Default

Interval 0 1 2 3

PD 6.60% 14.31% 28.30% 48.26% 68.79% 83.89% 92.49%

Ave Std Dev Max Q75 Median Q25 Min

0.7226 1.1467 6.0000 1.0000 0.0000 0.0000 0.0000

4 5 6

HIS

Type of Employment
Non formal employment = 0 Formal employment (social security) = 1

Sistema Credit Card Portfolio

100% 80% Frecuency 60% 40% 20% 0% 20.0% 18.0% 16.0% 14.0% % Default 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0 1 0.0%
T_Employ % Default

Interval 0 1

PD 24.26% 10.77%

Ave Std Dev Max Q75 Median Q25 Min

0.6227 0.4847 1.0000 1.0000 1.0000 0.0000 0.0000

T_Employ

Income Level
Number of times the minimum wage
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 40% 20% 0% 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%
Income % default

Interval 0 1 2 3

PD 40.03% 33.08% 26.79% 21.32% 16.71% 12.93% 3.20% 0.73% 0.16% 0.04% 0.01% 0.00%

% Default

[5,10]

[0,5)

>10

Ave Std Dev Max Q75 Median Q25 Min

5.4320 7.3905 116.9100 7.7700 2.6100 0.0000 0.0000

4 5 10 15 20 25 30 35

Income

INCOME _ MW (T0 ) =

IncomeT0 Minimum wageT0

Social Housing Institute Behavior

The cardholder has (or does not have = 0) a Social Housing Institute mortgage.
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 40% 20% 0% 18.0% 16.0% 14.0% 12.0% % Default 10.0% 8.0% 6.0% 4.0% 2.0% 0 1 0.0%
CREDIT (T0) % Default

Interval 0 1

PD 14.81% 17.25%

Ave Std Dev Max Q75 Median Q25 Min

0.1510 0.3581 1.0000 0.0000 0.0000 0.0000 0.0000

CREDIT (T0)

INFONAVIT is the Mexican Social Housing Institute (National Workers Housing Fund Institute) that gives mortgage credits and deducts the monthly payment from the worker salary.

Maturity of the Credit Card in the Bank

Age of the credit card measured in months

Credit Sistema Card Portfolio

100% 80% Frecuency 60% 40% 20% 0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Meses
MAT (T0) % Default

Interval 12 24 36 48

PD 19.11% 16.87% 14.85% 13.03% 11.40% 9.95% 8.67% 7.54% 6.55% 5.68%

% Default

MAT

>120

108

120

12

36

48

60

72

84

24

96

Ave Std Dev Max Q75 Median Q25 Min

46.8745 64.1524 455.5333 48.7000 22.0000 10.8000 0.2667

60 72 84 96 108 120

Maturity in the Credit Bureau

Age on the credit bureau
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 15.0% 40% 10.0% 20% 0% 5.0% >120 108 120 84 0.0% Meses 30.0% 25.0% 20.0% % Default
MAT_CB (T0) % Default

Interval 12 24 36 48 60

PD 24.91% 22.96% 21.11% 19.38% 17.75% 16.24% 14.83% 13.52% 12.31% 11.20%

12

24

36

48

60

72

MAT_CB (T0)

96

Ave Std Dev Max Q75 Median Q25 Min

91.2057 60.4804 455.5333 129.7333 81.8000 44.4000 0.9000

72 84 96 108 120

Open Accounts
Number of existing credit cards at the reference point (Open credit cards, not closed before the reference point).
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 40% 20% 5 y ms 0 1 2 3 4 0% 45.0% 40.0% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0%
ACCOUNTS TOT % Default

Interval 0 1 2 3

PD 13.61% 13.82% 14.03% 14.24% 14.46% 14.68% 14.91% 15.13% 15.36% 15.59% 15.83%

% Default

Ave Std Dev Max Q75 Median Q25 Min

6.9802 5.0575 84.0000 9.0000 6.0000 3.0000 0.0000

4 5 6 7 8 9 10

ACCOUNTS_TOT

Delinquency in the Credit Bureau

Indicates if the cardholder presented in the previous 12 months delinquency on any other debt obligation different than the credit card.
Credit Sistema Card Portfolio
100% 80% Frecuency 60% 15.0% 40% 10.0% 20% 0% 5.0% 0.0% 30.0% 25.0% 20.0% % Default
DELINQ_CB_HIST % Default

Interval 0 1

PD 6.59% 24.89%

Ave Std Dev Max Q75 Median Q25 Min

0.4754 0.4994 1.0000 1.0000 0.0000 0.0000 0.0000

DELINQ_CB_HIST

PD
Selected Variables The selected variables in the model are: Current Non-Payment (ACT): Number of consecutive periods, up to the reference point, in which the cardholder has not covered the minimum payment. Historical Non-Payment (HIS): Number of periods in which the cardholder has not covered the minimum payment in the last 6 months. Percentage of payment (% PAY): Amount of payments made by the cardholder over the total balance at the reference point. Credit Limit Use (% USE): Percentage that represents the total balance from the credit limit at the reference point. Maturity (MAT): Number of months elapsed since the opening of the credit card to the reference point.

Average Cardholder
The average cardholder of the Credit Card Loans Portfolio has the following value for each selected variable in the model. Credit Card Portfolio Actual Non-Payment (ACT) Historical Non-Payment (HIS) Maturity (MAT) Percentage of payment (%PAY) Credit Limit Use (%USE) 0.24 0.72 46.87 36.95% 48.51%

PD
Final Estimation of PD Receiver operating characteristic ROC = 86% Standardized Coefficients
Estimator Description Constant C1 C2 C3 C4 C5 ACT HIS MAT % PAY % USE Value -2.9704
Coeficientes estandarizados
0.4 MORAMIN_HIS 0.3 0.2 0.1 0 -0.1 -0.2 PJE_PAGO_T0 -0.3 -0.4 ANTIG_T0 MORAMIN_SA PUSO_LINEA_T0

INCUMP_90D_4 / Coeficientes estandarizados (Int. de conf. 95%)

+0.6730 +0.4696 -0.0075 -1.0217 +1.1513

Variable

)=

1 1 + e ( 2.9704+ 0.6730*C1 + 0.4696*C2 0.0075*C3 1.0217*C4 +1.1513*C5 )

Parameters Estimation

Loss Given Default (LGD)

LGD
Frequency of Classes
% Payment % Class 3 months Average % Recovery Payment

3 months

The Loss Given Default was established at 81%.

Estimation of Parameters

Exposure at Default (EAD)

EAD
Credit limit use at the time of analysis (horizontal axis) and the final exposure at the time of default (vertical axis)
3000%

2500%

Exposure at default / balance today Factor = EAD/Saldo_T0

%USE: Percentage that represents the balance at the reference point from the credit limit. Factor: Exposure at the date of default over the balance at the reference point. Balance_T0: Balance at the point of analysis (date of reference).

2000%

1500%

1000%

500%

0% 0% 50% 100% 150% 200% 250% 300% PUSO_LINEA_T0 %USE = Balance today / Credit Limit

%USE is the same variable used to estimate PD

EAD
An EAD adjustment factor is deducted from data.
%USE 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% 105% 110% 115% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60% 65% 70% 75% 80% 85% 90% 95% 100% 105% 110% 115% 120% Factor 845% 447% 333% 274% 237% 211% 192% 176% 164% 154% 145% 138% 131% 126% 120% 116% 112% 108% 105% 101% 100% 100% 100% 100%

Balance _ T 0 * Max C 5 0.5784 , 100%

C5 = Credit Limit Use (Balance_T0 / Credit Limit) at the reference point.

EAD = Balance_T0* Factor
1000% 900% 800% 700% Factor 600% 500% 400% 300% 200% 100% 0% 0% 20% 40% 60% % USE 80% 100% 120% 140%

%USE is the same variable used to estimate PD

Final Proposal
Current regulation for credit card reserve. Entered into effect september 2009 Credit Card Provisionsi = PDi * LGD * EADi Where:

PD = Si Si

C1 4

100% 1 1+ e ( 2.9704+0.6730*C1+0.4696*C2 0.0075*C3 1.0217*C4 +1.1513*C5 )

C1 < 4

C1 = Number of consecutive periods in which the cardholder didnt cover the minimum payment at the reference point C2 = Number of periods in which the cardholder did not cover the minimum payment in the last 6 months C3 = Maturity of the credit card in the Institution at the reference point (months) C4 = Amount of payment made by the cardholder over the outstanding balance at the reference point C5 = Percentage of the outstanding balance at the reference point over the credit limit.

LGD = 75%

EAD = Balance_ T 0 * Max C50.5784 , 100 %

Content
1. Introduction

2.

Provisions Based on Expected Loss for a Revolving Credit Portfolio

3.

Risk Analysis of the Credit Card Loans Portfolio

4.

Conclusions

Credit Card Loans Portfolio Interest Spread

The formula allowed for loan level expected loss estimation. Expected loss is compared to interest rate.
Expected Losses 40% 35% 30% 25% 20% 15% 10% 5% Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 De-07 Mar-08 Expected Losses were estimated for the Mexican credit card loans portfolio using the presented model for provisions. Spread

Spreads vs Expected Losses

Based on the risk-return relationship found for each bank, 4 types of institutions were identified.
60%

Over-Priced
MULTISEGMENT (low & high incokme) COMPETE IN NEW SECTOR

50%

40%

Spread

30%
WELL ESTABLISHED PRICE COMPETITION

20%

10%

0% 0%

Insufficient Price
10% 20% 30% 40% 50% 60%

Expected Losses

Maturity and Expected Losses

More recent clients to the financial sector are riskier.
120 Average Maturity in the Bank (months )

100
LOYAL CREDIT CARDHOLDERS

80

60
HIGH COMPETITION

40
The size of the circle indicates the expected loss EL %

20

CLIENTS THAT HAVE NEVER HAD A CREDIT CARD BEFORE

PRICE COMPETITION OLD USERS

0 0 20 40 60 80 100 120 Maturity in the Financial System (Credit Bureau first record) (months)

1/ Expected Loss is the average of the expected losses for the period between April 2006 and March 2007

IRB model validation

PD CNBV vs PD Bank X
IRB

PD CNBV vs PD Bank Y

Modelo PD CNBV

PD Model IRB Observed default rate PD CNBV

Interest rate differentation according to risk characteristics of clients

Payment / outstanding balance

Outstanding balance / Credit limit

*/ Ex-post (in the next 12 months after the horizontal axis computation)

PD Through the Cycle vs PD Point in Time

Content
1. Introduction

2.

Provisions Based on Expected Loss for a Revolving Credit Portfolio

3.

Risk Analysis of the Credit Card Loans Portfolio

4.

Conclusions

Credit Card Loans Portfolio

The impact in the system was significant (average 2.14 times the previous requirement).
70% 60% 50% 40% 30% 20% 10% 0%
BANK 1 BANK 2 BANK 3 BANK 4 BANK 5 BANK 6 BANK 7 BAN K 8 BANK 9 BANK 10 SISTEMA

Institution

Expected Loss vs Incurred Loss 2.13x 1.8x 1.75x 2.14x 2.61x 2.53x 2.26x 3.25x 1.56x 2.02x 2.14x

BANK 1 BANK 2 BANK 3 BANK 4 BANK 5 BANK 6 BANK 7 BANK 8 BANK 9 BANK 10 PORTFOLIO

Incurred Loss

Expected Loss

Capital Requirement and Provisions Credit Card Portfolio

18.4%
Provisions (Incurred Loss) 9.3% Expected Loss 18.4% BIS I (1-k=0.6487) 17.3% BIS II (1-k=0.001) 36.5%

FRECUENCY

Basel II & expected loss protection

18.12 % 8.%

36.5%

9.3%

17.3%

% portfolio

Basel I & incurred loss protection

Individual bank estimation

Best bank
Reserves 8.10% Expected loss 13.70% BIS I (1-k=0.6689) 16.10% BIS II (1-k=0.001) 27.49 %

8% cartera 13.79% cartera

Individual bank estimation

Worst bank
Reserves 15.84% Expected loss 30.21% BIS I (1-k=0.6689) 23.84% BIS II (1-k=0.001) 54.11%

8% cartera

23.90% cartera

Systemic PD, EAD, LGD as validation method

In Mexico no bank had an internal model before the introduction of this rule because the incentive of capital reduction was the opposite. This method does not intend to substitute internal models. On the contrary it seeks to incentivize its use and development by setting a comparable standard as the standard method of reserves. One bank has certified its internal model in parallel with the introduction of this rule. Loan level comparisons were done and general parameters compared for sample portfolio. Differences in parameters were modest and subject to explanation. This approach allows a rich validation process as specific differences on PD estimation can be explained by bank specific policies which are made evident by comparing parameter estimates.

Conclusions
The National Banking and Securities Commission (CNBV) is gradually changing the regulation from an incurred loss to an expected loss provisioning scheme The first portfolio that changed was the revolving consumer loans (credit cards) which is now being provisioned with the presented expected loss model. In March 2011 mortgage and personal loans were introduced. September 2011 saw the state and municipalities reserve rule change and december 2011 is the objective date for corporate and SMEs loans (D&B score). The objectives of these reforms are to recognize losses in a timely manner, to assure that provisions cover losses for a 12 month horizon, to apply international standards and encourage banks to use more information in the process. This type of models also represent an incentive for the banks to develop their internal rating models for provisioning and capital assessment.

Systemic estimation of PD, LGD and EAD for credit card as a reserve requirement and validation method.
Mexican Experience