1. Lawrence Mielnicki, Ph.D. FleetBoston Financial Director, Retail Credit Risk Analysis Challenges In Validation: Taking the Study Findings Forward A Retail Perspective

2. Risk Ratings May Be Less Problematic For Retail Lending Than For Commercial Lending 23 of 26 respondents use statistical models in some aspect of their decisioning/account management process Portfolios are large with sufficient defaults for validation purposes Robust internal and external data is available Default definition not consistent but this is not a roadblock

3. Retail Model Validation Is Already a Best Practice Activity -- At least in the U.S. OCC Bulletin 2000-16 sets standards for the development, use, and validation of statistical models External vendor models can be validated on bank data, tracked, and re-validated at appropriate intervals Internally developed models must pass certain tests that go beyond the use of statistical measures such as GINI and K-S Data integrity may be an issue especially for external vendor supplied models

4. From Scorecards to Risk Ratings The preponderance of statistical risk measurement tools used in retail lending are in the form of “scorecards” –Scorecards are just a convenient way to implement statistical models Underlying most scorecards is a probability something bad will either happen or not –The probability may be default but most likely something else like some state of delinquency This prediction needs to be converted to a probability of default

5. Do We Need A Common Risk Rating Scheme Across All Asset Classes? Matter of personal preference Pros Places all credit risk on an equal footing for reporting ….. Cons There are many more opportunities for risk segmentation in retail portfolios ….. Based on the QIS 3, this is not a requirement for Basle II AIRB

6. Challenges Going Forward Banks need to cleanse their processes of “black box” models — external vendors will need the message that “black box” models no longer sufficient for regulatory purposes Scorecard development in the future should recognize the multiple uses of the underlying models — stoplight decisions (red, amber, green) are only one application of the tools Stress testing of inputs Guidance from the supervisors regarding the level of regulatory validation for Basle AIRB purposes would be helpful — is the OCC 2000-16 approach taken (validate the internal validation process) or — will the supervisors look to validate each model independently?

7. Questions and Answers

8. Challenges In Validation: Taking the Study Findings Forward A Retail Perspective Lawrence Mielnicki, Ph.D. FleetBoston Financial Director, Retail Credit Risk Analysis