Barclays 2009 Annual Report Download - page 94

92 Barclays PLC Annual Report 2009 www.barclays.com/annualreport09
Risk management
Barclays risk management strategy
continued
Modelling risk
Risk taking on any meaningful scale requires quantification. Barclays uses
risk models in an extensive range of decisions, from credit grading, pricing
and approval to portfolio management, risk appetite setting, economic
capital allocation and regulatory capital calculations.
The key inputs into the models used to quantify credit risk are:
– Probability of default (PD).
– Exposure at default (EAD).
– Loss given default (LGD).
These models are used in a range of applications that measure credit risk
across the Group. For example, Barclays can assign an expected loss over
the next 12 months to each customer by multiplying these three factors.
We calculate probability of default (PD) by assessing the credit quality of
borrowers and other counterparties. For the sake of illustration, suppose a
customer has a 0.5% probability of defaulting over a 12-month period.
The exposure at default (EAD) is our estimate of what the outstanding
balance will be, if the customer does default. Supposing the current balance
is £1,000, our models might predict a rise to £1,200 by then. Should
customers default, some part of the exposure is usually recovered. The part
that is not recovered, together with the economic costs associated with the
recovery process, comprise the loss given default (LGD), which is expressed
as a percentage of EAD. Supposing the LGD in this case is estimated to be
30%, the expected loss for this customer is: 0.5% x £1,200 x 30% or £1.80.
The Group has an extensive range of models in use, covering
estimations of PD, EAD, LGD as well as many other types of risk besides
credit risk. The models are developed and owned by each business unit and
used to measure risk in their portfolios. To minimise the risk of loss through
model failure, the Group Model Risk Policy (GMRP) was developed. It is
managed by the independent Group Risk function and was reviewed and
expanded during 2009.
The GMRP helps reduce the potential for model failure by setting
Group-wide minimum standards for the model development and
implementation process. The GMRP also sets the Group governance
processes for all models, which allows model performance and risk to be
monitored, and seeks to identify and escalate any potential problems at an
early stage.
To ensure that the governance process is effective, and that
management time is focused on the more material models, each model is
provided with a materiality rating. The GMRP defines the materiality ranges
for all model types, based on an assessment of the impact to the Group in
the event of a model error. The final level of model sign-off is based on
materiality, with all of a business unit’s models initially being approved in
business unit committees. The more material models are also approved
at the Group-level Material Models Technical Committee, and the most
material models require further approval by the Executive Models
Committee, a sub-committee of Group Executive Committee.
This process ensures that the most significant models are subject
to the most rigorous review, and that senior management have a good
understanding of the most material models in the Group. Although the
final level of model sign-off will vary, depending on model materiality, the
standards required by the GMRP do not change with the materiality level.
The GMRP also sets detailed standards that a model must meet during
development and subsequent use. For new models, documentation must
be sufficiently detailed to allow an expert to understand all aspects of model
development such that they could reproduce the model. It must include a
description of the data used for model development, the methodology used
(and the rationale for choosing such a methodology), a description of any
assumptions made, as well as details of the strengths and weaknesses of
the model.
All new models are subject to validation and independent review before
they can be signed off for implementation. The model validation exercise
must demonstrate that the model is fit for purpose and provides accurate
estimates. The independent review ensures that the model development
has followed a robust process and that the standards of the GMRP have
been met, as well as ensuring that the model satisfies business and
regulatory requirements. In addition, the most material models are subject
to independent review by Group Risk. Once implemented, all models are
subject to post-implementation review. This confirms that the model has
been implemented correctly and behaves as predicted.
The GMRP also sets the requirements for ongoing performance
monitoring and the annual review process. Once implemented, all models
within the Group are subject to ongoing performance monitoring to ensure
that any deficiencies are identified early, and that remedial action can be
taken before the decision-making process is affected. As part of this process,
Model Governance
Group Risk Technical Committee
Executive Models Committee
Group Risk Oversight Committee
Group Material Models
Technical Committee
Business Unit Technical Committee