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Credit Risk Modeling and Internal Capital Allocation Processes: Implications for a models-based regulatory bank capital standard

by David Jones of the Federal Reserve Board of Governors, and
John Mingo of the Federal Reserve Board of Governors

March 1999

Abstract: This paper surveys the current state-of-the-art in credit risk modeling at large U.S. banks. Within this context, the paper examines the near-term feasibility of an internal models approach to setting formal regulatory capital requirements for banks, as a replacement for the 1988 Basle Accord. Such an overhaul of the international capital standards would require, in our view, specific attention to several deficiencies in current modeling practices, including questions relating to model specification, parameter estimation, and model validation procedures. The paper also discusses possible uses of internal risk models for setting regulatory capital requirements against selected credit instruments and/or improving examination guidance dealing with the capital adequacy of large, complex banking organizations.

JEL Classification: G18, G28, G32, E58, L89.

Keywords: Bank, Capital, Risk, Regulation.

Published in: Economic Policy Review, Vol. 4, No. 3, (October 1998), pp. 53-60. , and
Journal of Economics and Business, Vol. 51, No. 2, (March 1999), pp. 79-108.

Previously titled: Industry Practices in Credit Risk Modeling and Internal Capital Allocations: Implications for a models-based regulatory capital standard

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