UBI Banca Group

D. Banking group - Models for the measurement of credit risk
With regard to the measurement of credit risk, the Group has developed a portfolio credit risk model
using the Algorithmics PCRE calculation engine. The model, which includes PD and LGD used for
supervisory purposes among its input variables, considers the total risk for a loan portfolio by
modelling and capturing the component resulting from the correlation of counterparty defaults,
calculating credit losses and the capital at credit risk at portfolio level. This involves the use of a
complex method for measuring the total risk of the entire portfolio, designed to capture mutually
dependent phenomena in changes in counterparty creditworthiness and to determine the distribution
of total losses for the whole portfolio as the basis for calculating risk.
Calculation of the correlation between defaults therefore makes it possible to establish the
concentration of risk within a portfolio, which can be used as a basis both for managing and
mitigating total risk by employing an appropriate diversification strategy and also for implementing
efficient pricing policies.
The model proposed uses an approach similar to that of the Merton model (1974). Counterparty
creditworthiness is given by an intermediate variable, the Credit Worthiness Index (affected by two
components: a system and a specific component). The future level of this variable determines
creditworthiness on the basis of specially calculated thresholds and therefore also any corresponding
losses.
The analysis of changes in counterparty creditworthiness can be performed over a time period of
longer than one year with intermediate steps.
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