Using Credit Risk Models for Regulatory Capital: Issues and Options

Regulatory capital standards based on internal credit risk models would allow banks and supervisors to take advantage of the benefits of advanced risk-modeling techniques in setting capital standards for credit risk. The internal-model (IM) capital standards for market risk provide a useful prototype for IM capital standards in the credit risk setting. Nevertheless, in devising IM capital standards specific to credit risk, banks and supervisors face significant challenges. These challenges involve the further technical development of credit risk models, the collection of better data for model calibration, and the refinement of validation techniques for assessing model accuracy. Continued discussion among supervisors, financial institutions, research economists, and others will be key in addressing the conceptual and theoretical issues posed by the creation of a workable regulatory capital system based on banks