Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

Model validation

Under the IRB approach for credit risk or the advanced measurement approach for operational risk, banks will be allowed to measure the risks, such as the PD. To encourage banks to provide an adequate measurement of risks, central banks will supervise the validity of the models used by banks. This is done in part by comparing the prediction of the models with actual losses. The validation of risk measurement models raises a further question: who will supervise the fiercely independent central banks? Who will guard the guards?

By now, you are no longer a layman on Basel II, but fully fluent with the Basel II jargon: IRB, PD, LGD and AMA.

Key Points The intent of Basel II is to align better capital and risks. The capital adequacy ...