Featured Column: Credit Edge


The CRR3 Output Floor: A Strange Backstop for Credit Risk Measurement

The latest update to the capital requirements regulation under Basel 3.1 reinforces the notion that EU supervisors strongly favor a standardized approach (SA) to credit risk measurement over an...

March 22, 2024 | By Marco Folpmers


EU Banks Enjoy Success, But Must Stay Vigilant About Emerging Risks

European banks experienced record-breaking profitability and capitalization toward the end of last year, according to a recent report from the European Banking Authority (EBA). But in volatile...

February 9, 2024 | By Marco Folpmers


The Risk-Reward of Buy Now, Pay Later

Buy Now, Pay later (BNPL) applications offer consumers the opportunity to defer payment on goods and services. The usage of BNPL has increased six-fold globally since 2019, and now represents a...

January 12, 2024 | By Marco Folpmers


How Generative AI Can Solve a Traditional Risk Modeling Problem

Developing sector-driven correlation matrices is no small task for risk modelers. Traditionally, these modelers have used a combination of equity return data and expert judgment to measure...

December 8, 2023 | By Marco Folpmers


The 2023 Banking Turmoil: A Middle-of-the-Road Crisis

The failures earlier this year of a group of midsized U.S. banks grabbed headlines and yielded many questions about the effectiveness of their risk management programs. But how big was this crisis,...

November 17, 2023 | By Marco Folpmers


How Regulatory Backstop Measures Can Lead to Worse Risk Management

European banks, amid the current environment of rising interest rates, inflation volatility and geopolitical risk, now face the tall task of calculating expected credit losses (ECL) in compliance...

October 6, 2023 | By Marco Folpmers


How Generative AI Will Disrupt Credit Risk Modeling

Generative AI has been a smash hit with consumers. Earlier this year, for example, OpenAI’s ChatGPT chatbot set a record by racking up 100 million users within two months of its launch. But does this...

September 1, 2023 | By Marco Folpmers


Does Visualization Improve the Explainability of ML Models?

Credit risk modelers are under pressure to improve the accuracy of default projections – and are increasingly using models driven by machine learning (ML) to achieve this goal. ML models, moreover,...

July 28, 2023 | By Marco Folpmers


Foundation IRB: An Inferior Option for Credit Risk Modeling?

Banks are going to be required to use the so-called foundation approach (F-IRB) to credit risk measurement, for some key asset classes, under the Basel III accord. But is removing the option for...

June 16, 2023 | By Marco Folpmers


Agile Approaches for Credit Risk Modeling: Curse or Blessing?

Credit risk models that are adaptable, flexible and fast, one could argue, are what’s needed in the current financial environment of uncertainty and volatility. Banks need to be able to respond to...

May 19, 2023 | By Marco Folpmers


Credit Risk Measurement: Basel III’s External Ratings Dilemma

One of the key factors behind the 2007-08 global financial crisis was an overreliance on external ratings. Could we be heading down a similar road after the expected January 2025 implementation of...

April 14, 2023 | By Marco Folpmers


When to Change IFRS 9 Scenario Weights for ECL: A Simple Rule

European banks that must comply with the IFRS 9 financial reporting standard suffer today from a lack of supervisory guidance on how, exactly, they should go about weighting the scenarios they use to...

March 10, 2023 | By Marco Folpmers

Culture & Governance

Under the Hood: Evaluating the Basel Committee’s Self-Analysis of Basel III

How effective have Basel III reforms truly been? A December 2022 report by the Basel Committee on Banking Supervision (BCBS) takes a self-congratulatory tone. However, while banks are certainly...

January 27, 2023 | By Marco Folpmers


Two Regulators, Two Views: BCBS and ECB Offer Contrasting Perspectives on Bank Credit Risk

In October, two regulatory studies of great interest to credit risk managers were published: the Basel Committee on Banking Supervision’s (BCBS) paper on buffer usability and procyclicality, and a...

November 11, 2022 | By Marco Folpmers


The Expected Credit Losses Dilemma: Weighing IFRS 9’s “SICR”

In these volatile and unpredictable times, European banks continue to face a major obstacle in their efforts to comply with the IFRS 9 accounting standard for expected credit losses (ECL): assessing...

October 21, 2022 | By Marco Folpmers


Model Validation: Dissecting the Boundaries of a Rules-Based World

Banks’ internal ratings-based (IRB) processes for validating credit risk models have historically been subject to rules-based supervision established by the European Banking Authority (EBA). However,...

September 9, 2022 | By Marco Folpmers and Gerrit Reher


Economic Capital: The Power of Diversification

Economic capital has always been a key measure of a bank’s solvency. But under Basel III, the set of international banking regulations that are scheduled for implementation next January, proper...

August 12, 2022 | By Marco Folpmers


The Problems with Ritualistic Risk Management

Financial institutions and regulators have demonstrated their adaptability amid the volatile market conditions sparked by the pandemic, but COVID-19 also reminded us that there is still more work to...

July 8, 2022 | By Marco Folpmers


EBA’s Latest Risk Report for European Banks: Interesting, But Mistimed

Challenged by lockdowns, temporary or permanent closures of businesses, and cash-flow shortfalls for many of their business clients, European banks have faced an unprecedented “real-life” stress test...

June 10, 2022 | By Marco Folpmers


Model Validation for Credit Risk: A Critical Deficiency in the Jeffreys Test

A loan portfolio with zero defaults over, say, the past 12 months, is generally considered excellent – as long as the return on the portfolio is strong, of course. However, for credit risk...

May 13, 2022 | By Marco Folpmers


New Drivers for Credit Risk: Increasing Interest Rates and Rising Geopolitical Risk

Credit risk and interest rate risk are often perceived by banks as worlds apart, thanks in part to the well-established risk taxonomy of the Basel Committee on Banking Supervision (BCBS). However, in...

April 8, 2022 | By Marco Folpmers


Basel III: The Impact of the New Probability of Default Input Floor

In 2023, as part of a Capital Requirements Regulation (CRR3) amendment, the probability of default (PD) input floor will rise from three basis points (bps) to five. While this may not seem like a...

February 11, 2022 | By Marco Folpmers


The Rise of Machine Learning in IRB Models: New EBA Outlook Could Open Door

Until now, European banks have been hesitant to apply machine learning (ML) to their internal-ratings-based (IRB) models for credit risk. The supervisory requirements they had to meet to ensure they...

December 10, 2021 | By Marco Folpmers


The Changing Credit Risk Management Landscape at European Banks

Throughout 2021, European banks have devoted considerable time to reassessing and recalibrating their probability-of-default (PD) and loss-given-default (LGD) models. Consequently, irregularities in...

November 12, 2021 | By Marco Folpmers


Model Risk: Why Size Matters for Banks

As a general rule, the bigger the bank, the more sophisticated its credit-risk models. But determining the size of a bank is very dependent on one's measurement approach. The same holds true, on a...

October 8, 2021 | By Marco Folpmers


Credit-Risk Models Based on Machine Learning: A 'Middle-of-the-Road' Solution

Financial institutions are using machine-learning-driven models for everything from anti-money laundering to fraud protection. However, while ML models have undoubtedly yielded gains in these areas,...

September 10, 2021 | By Marco Folpmers and Linda Torn


Probability of Default: The Pluses and Minuses of Transition Matrices

Transition matrices measure the transition probabilities for credit-risk ratings over specific time intervals, and are among the most vital tools at the disposal of a credit risk manager for...

August 13, 2021 | By Marco Folpmers


Beyond Probability of Default: How to Expand the Use of the Jeffreys Test

The Jeffreys test is the most important diagnostic tool for assessing the calibration of the bucket probability of default (PD). However, it actually has a wider range of applications. Potentially,...

July 9, 2021 | By Marco Folpmers


The Riskiness of Small Banks vs. Large Banks: Size Matters

Bigger is better. At least, it seems, with respect to the riskiness of banks. The capital, profitability and credit risk differences between small and large banks were highlighted in a European Bank...

June 11, 2021 | By Marco Folpmers

Culture & Governance

The New Basel Framework for Climate Risk Management: Pros and Cons

The Basel Committee on Banking Supervision (BCBS) recently published an interesting framework for climate risk that includes helpful advice on how a financial institution can integrate climate...

May 14, 2021 | By Marco Folpmers


The Skewed Generalized T Distribution: A Swiss Army Knife for Tail Risk

Every risk professional knows that price shifts can widely diverge. Daily or weekly returns can go up or down in a more significant way than predicted by a normal distribution. When assessing and...

April 9, 2021 | By Marco Folpmers


Pros and Cons of the Six Sigma Approach for Credit Risk Management

Over the past 12 months, bank have faced a myriad of difficulties, ranging from data deficiencies to dwindling profits to rising default risk and falling interest rates. Complicating matters further,...

March 12, 2021 | By Marco Folpmers


Tempered Expectations: The Hope and Reality of AI in Risk Management

A couple of years ago, risk professionals had great expectations about artificial intelligence (AI). But the expected paradigm shift hasn't yet occurred - at least not for probability of default (PD)...

February 12, 2021 | By Marco Folpmers


Probability of Default: Pros and Cons of the Population Stability Index

All banks need to meet quality standards for their probability of default (PD) rating systems, and the Population Stability Index (PSI) is an easy-to-use PD stability assessment tool. However, it's...

January 29, 2021 | By Marco Folpmers


The Uncertain Future of Credit Risk in Europe: Banks, Borrowers, and Expiring Moratoria

In response the pandemic, borrowers across Europe were given more time to repay their loans in 2020, with the help of government-support programs and guidelines issued by the European Banking...

December 11, 2020 | By Marco Folpmers


Economic Capital in Times of COVID-19

In the aftermath of the 2008 global financial crisis (GFC), economic capital (EC) - a popular tool for calculating capital requirements across different risk types - fell into disfavor at some banks....

October 9, 2020 | By Marco Folpmers


Probability of Default: How to Pass the Jeffreys Test and Improve Predictive Ability

Proper back-testing is crucial for any bank that submits its PD and LGD models to its supervisor for approval. To meet the requirements of regulators like the European Central Bank (ECB), banks must...

September 18, 2020 | By Marco Folpmers


The Role of AI in Credit Risk: A Conversation

When working earlier this year in San Francisco, I found myself in a small breakfast restaurant in the Embarcadero area, where I was enjoying breakfast and the newspaper. Since the place was...

August 14, 2020 | By Marco Folpmers


The Effects of COVID-19 on Expected Credit Loss Modeling

Contending with the economic shocks of COVID-19 - including unemployment, decreasing revenues and high projected credit losses - banks must now overcome unprecedented credit risk management...

June 19, 2020 | By Marco Folpmers

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