An exploration of the use in practice of credit risk models

Koshy, Jacob (2012) An exploration of the use in practice of credit risk models. (DBA thesis), Kingston University, .


Credit risk is treated as a major risk in banks and has become more important with the 2008 financial crisis and the subsequent regulatory controls, mainly in the form of new changes in Basel II and the proposed Basel III requirements. The use of credit risk models grew in the 2000s due to both the use of internal models in Basel II as well as bank use for economic capital calculations. These models have a large and growing influence on how credit risks are managed, yet there is a gap in the current literature on how these models are used in practice. This research explores their use in banks to help provide academic and management insight into the actual use of credit risk models. An interpretative approach using qualitative case study was undertaken in three banks using face-to-face interviews with the key credit risk managers that worked in the methodology, decision making, monitoring, control and reporting areas. While interviews were the main source of data for the research, it was supported by observation and a review of documentation that related to the use of credit risk models in the bank. The research findings show the merits in examining the social, organisational and cultural constructions as well as the role of individuals in this process. This evidences the usefulness of interpretive research, which thrives on diversity of meanings as opposed to comparing just the technical aspects of the models as found in more traditional studies. This research provides a contribution to the academic understanding of the use of credit risk models not found in any of the studies to date. This includes new insights into the use of qualitative information, the use of expert judgement (including an element of gut feel), how model complexity can detract from model use and the importance of aligning models to the risk appetite of the bank. These findings are significant both from an academic and practitioner aspect as they open up commonly-hidden processes on how these models are used in practice.

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