Basel II: Working Papers on the Validation of Internal Rating Systems

10 February 2005




In June 2004, the Basel Committee on Banking Supervision issued a revised Basel II Framework. In light of the requirement under Basel II for banks and their supervisors to assess the soundness and appropriateness of internal credit risk measurement and management systems, the development of methodologies for validating external and internal rating systems is clearly an important issue.

A subgroup, the Validation Group, was formed to review and develop research on the validation of rating systems that would be useful to banks and supervisors as they consider options for implementing Basel II. The work of the Validation Group collected in this volume of studies addresses a number of topics on rating system validation, with a particular focus on empirical validation methods.

The main objectives of the project have been:

  • to classify rating systems and their dynamic properties, and to develop a common terminology for validation purposes,
  • to review validation methodologies that are currently applied in bank practice, and
  • to analyse validation methodologies for the three key risk components probability of default (PD), loss given default (LGD) and exposure at default (EAD) from a theoretical perspective.

    Importantly, the collection of studies presented here is not intended to represent a comprehensive survey of all available validation methods and processes. Rather, the RTF expects that this research will provide a valuable input to the work of the Basel Committee’s Accord Implementation Group (AIG), national supervisors, and banks as they develop approaches for validating the risk parameters and rating systems needed to implement Basel II. In addition, it should be emphasised that these studies largely reflect the views of individual authors, and should not be viewed as representing specific Basel Committee guidance for national supervisors or financial institutions.

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