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Survey shows that banks continue to enhance their methodologies for credit risk

email this aricle - Survey shows that banks continue to enhance their methodologies for credit risk - London - 21 May 2007 print this article - Survey shows that banks continue to enhance their methodologies for credit risk - London - 21 May 2007
A survey conducted by InteDelta, the risk management consultancy, shows that major banks continue to invest heavily in the development of methodologies and systems for the measurement of Potential Future Exposure (“PFE”) for their derivatives portfolios.

The survey shows that Monte Carlo simulation is the most extensively used methodology, and banks are implementing Monte Carlo for the first time or moving a larger proportion of their portfolio onto Monte Carlo. The less sophisticated “mark to market plus add-on” approach continues, however, to be extensively used. A minority of banks use analytical techniques and historic simulation.

Among the banks using mark to market plus add-on, there is a wide variety in the sophistication of methodology. This ranges from banks still using BIS 1 add-ons to those that have developed sophisticated methodologies for taking account of scenario consistency, close-out netting and collateral.
Most banks are planning to make improvement to their PFE environment in the coming year. The main drivers for this are:
• Required improvements in accuracy
• Need to calculate Expected Positive Exposure under same framework as PFE
• Free up credit limits

Many banks using Monte Carlo simulation have purchased third party simulation engines. Mark to market plus add-on is more likely to be implemented using an in-house system.

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