Turkish Banks Move Forward To New Approaches For Credit Risk Modelling

By Stefano Giovanni Romano | 17 June 2016

The long journey has just begun. In the wake of the Basel II framework, Turkish banks are beginning their transition from standardised to Internal Ratings Based (IRB) approach models for credit risk management, with an eye on the new guidelines the European Banking Authority. This shift will change not only the way banks develop, validate and implement credit risk models, but will also affect their organisational structure, requiring a more integrated cooperation between risk, finance, IT and commercial departments.

Recognising the urgency to build new forms of integration within the bank’s different areas was  the main message communicated at the one-day conference organised 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 local and international regulators to the most prominent banks in Turkey. Alongside the main panels, workshops were 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 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 standardised 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 Òªetinkaya, Head of Risk Department at BDDK, 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 Òªetinkaya, 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 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.

Do Turkish banks think to be prepared for this new era? Optimism is widespread, even if difficulties – they admit – will be on the way. “We are in a good shape, we were allowed enough time to get prepared and internalize the IRB approach” says Bora Örsҁelik from Finansbank, who underlines that banks will leverage this preparation to deal with the IFRS 9 implementation challenge as well. “Quite good timing” he smiles.

“The processes inside the bank have to strengthen the use of models” states Gürcan Kırmızı from Yapi Kredi, “Not only credit, but also monitoring and underwriting processes will use them.” Mr Kɪrmɪzɪ stresses one particular feature Turkish banks have always struggled with: clear internal communication. “Risk management teams should begin to communicate more and more, allowing other teams to better understand and benefit from the models developed.”

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. But 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. In the meanwhile, discussions about turning the Advanced IRB approach into a more consistent framework will go on.

By Stefano Romano, Head of Credit and Operation Risk Area and Partner, Prometeia.

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