NATIXIS_PILLAR_III_2017_EN

5 CREDIT RISK

Credit risk: internal ratings-based approach

VALIDATION OF INTERNAL MODELS 5.7.2

Rating tool performance monitoring 5.7.2.2 and backtesting Backtesting and benchmarking are an integral part of the model approval process. Backtesting and performance-monitoring programs are used at least once a year to ensure the quality and reliability of rating models, LGD estimates and probability of default scales. They include a detailed analysis based on a range of indicators, e.g. differences in terms of severity and migration compared with agency ratings, observed defaults and losses and changes in ratings prior to default, and the performance measurements of LGD models, based on the quantitative analysis of historical data and supplemented by qualitative analysis. The rating methods are periodically checked and undergo external benchmarking to ensure the consistency of ratings produced using expert appraisal methods, as well as their robustness over time according to regulatory requirements. The monitoring methods are defined through a backtesting procedure tailored to each type of model. For Natixis, the Corporate (including Structured Finance), Interbank and Sovereign portfolios, which are handled using dedicated rating tools, have the lowest default rates (Low Default Portfolios). These portfolios are backtested in accordance with their specific nature, namely the low number of defaults and the difficulty in creating and maintaining a PD scale based on internal data. The backtesting procedure, which draws on these data (and sometimes external data in the case of backtesting of the banking model or the Major Corporate rating grids particularly), consists of two stages: an analysis of the absolute performance, which is based on the default rate and internal migrations, and an analysis of the relative performance, which is based on a comparison with external ratings. Alerts are triggered by performance rules and indicators as necessary. These checks are carried out through several processes, such as quarterly meetings of the Rating Analysis Committee (CANO) and the backtesting of the various rating models, which is carried out between once and four times a year depending on the scope. The role of this committee is to: provide a forum for the presentation of the results of a performance and stability measurements; analyze the indicators whose alert thresholds have been a exceeded; decide on any measures to be taken to correct any deviations a or anomalies. These measures may take different forms, including changes to rating practices, methodologies, performance analyses or alert threshold values. The severity of the internal ratings compared with the agency ratings is examined. Natixis therefore analyzes all the internal ratings of counterparties that are also rated by the rating agencies (Standard and Poor’s, Moody’s and Fitch). The extent to which the risk assessments are aligned can be determined through these analyses. Rating method performance monitoring and backtesting of PD

Validation of models 5.7.2.1 In accordance with regulatory requirements, Natixis has established internal model validation policies and procedures for evaluating credit and counterparty risk. This independent model validation policy is part of its wider risk model management framework. Within the Model Risk & Risk Governance Department which reports to the Chief Risk Officer, Model Risk Management is responsible for the governance and standards applicable to a model’s life cycle. The various stages of a model’s life cycle - design, IT development, validation, and use - are clearly presented and the roles and responsibilities of each participant specified and detailed. The validation of internal rating models is carried out by the validation team from BPCE’s Risks, Compliance and Permanent Control division or, with the authorization of BPCE’s Group Modeling Committee, by Natixis’ Risk Department’s Model Risk Management team. Pursuant to BPCE’s validation charter, the validation covers a review of the relevance, consistency and integrity of models and the reliability of input and output. This validation process comprises four steps: quantitative analysis: analysis of proxies, sizing methods, risk a indicators, aggregation rules, etc.; performance and governance analysis: model backtesting and a benchmarking, precision and consistency analysis, stress tests, etc.; analysis of data quality and implementation of the model: a analysis of the quality and representativeness of data, integrity of controls, error reports, comprehensiveness of data, etc.; use test: the validation team ensures that the internal models a are used by qualified staff, that usage procedures are documented and up to date, that ex-post controls are performed, etc. The everyday design, modification and management of a model (including backtesting) is carried out by model designers on behalf of the model’s owner. The independent Model Risk Management entity is called upon for all new models as well as for all modifications or improvements to existing models. On an annual basis, this team regularly reviews the rating models which cover the analysis of backtesting and use tests. The third line of defense is the Internal Audit Department which annually reviews internal rating models and compliance with the risk model management framework and the correct application by Model Risk Management of its own policies and procedures. The conclusions and results of the model validation process carried out within Natixis are presented to the Risk Model Oversight Committee for confirmation, then submitted to the Model Risk Management Committee for approval. They are then sent to the Standards and Methods Committee within BPCE’s Risks, Compliance and Permanent Control division for final approval and potential reporting to the supervisor. The Risk Model Oversight Committee is chaired by the Head of the Model Risk & Risk Governance Department; the Risk Model Management Committee is chaired by Natixis’ Chief Risk Officer who is a member of the Senior Management Committee.

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NATIXIS Risk report Pillar III 2017

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