Credit risk management models

Financial institutions are just beginning to realize the benefits of credit risk management
models. These models are designed to help the risk manager project risk,
measure profitability, and reveal new business opportunities.
This chapter surveys the current state of the art in credit risk management
models. It provides the reader with the tools to understand and evaluate alternative
approaches to modeling. The chapter describes what a credit risk management model
should do, and it analyses some of the popular models. We take a high-level approach
to analysing models and do not spend time on the technical difficulties of their
implementation and application.1
We conclude that the success of credit risk management models depends on sound
design, intelligent implementation, and responsible application of the model. While
there has been significant progress in credit risk management models, the industry
must continue to advance the state of the art. So far the most successful models
have been custom designed to solve the specific problems of particular institutions.
As a point of reference we refer to several credit risk management models which
have been promoted in the industry press. The reader should not interpret this as
either an endorsement of these models or as a criticism of models that are not cited
here, including this author’s models. Interested readers should pursue their own
investigation and can begin with the many references cited below.