Vendor models for credit risk measurement and management

A number of vendors produce and sell products that are designed to support credit-risk measurement and management functions within financial institutions. Such products may comprise risk measurement models, data, or systems developed by external commercial entities. Interest in such vendor products has grown recently, as financial institutions seek to meet new requirements such as the internal ratings-based (IRB) approaches of the Basel II framework.

Even though individual institutions have primary responsibility for assessing the suitability of vendor products as part of their validation processes, supervisors have a natural interest in understanding the details of these products as well. Supervisors need to assess whether the use of the model, as opposed to the model itself, is in accordance with regulatory expectations and requirements.

Against this backdrop, the Research Task Force of the Basel Committee initiated a review of selected vendor credit-risk products, focusing on models that could be used to estimate probability of default, loss-given-default, or exposure at default, and models that could be used to assign ratings or produce credit scores, for wholesale or retail credit exposures.

This paper provides a high-level discussion of certain observations from the RTF review of vendor products for credit risk measurement and management.