BBVA in 2012

Credit riskCredit risk quantificationmethodologiesThe risk measurement and management models used by BBVA have made it a leader in bestpractices in the market and in compliance with Basel II guidelines.The Bank quantifies its credit risk using two main metrics: expected loss (EL) and economiccapital (EC). The expected loss reflects the average value of the estimated losses (i.e. thecost of the business) and is associated with the Group’s policy on provisions, while economiccapital is the amount of capital needed to cover unexpected losses (i.e. if actual losses arehigher than expected losses).These risk metrics are combined with information on profitability in the value-basedmanagement framework, including the profitability-risk binomial into the decision-makingprocess, from the definition of business strategy to the approval of individual loans, pricesetting, assessment of non-performing portfolios, incentives to the different areas in theGroup, etc.There are three risk parameters that are essential in the process of calculating the EL andEC measurements: the probability of default (PD), loss given default (LGD) and exposure atdefault (EAD). They are generally estimated using the available historical information andare assigned to transactions and customers according to their particular characteristics. Inthis context, the credit rating tools (ratings and scorings) assess the risk in each transaction/customer according to their credit quality by assigning them a score. This score is then usedin assigning risk metrics, together with additional information such as transaction seasoning,loan-to-value ratio, customer segment, etc. The increase in the number of default events inthe current economic situation reinforces the soundness of the risk parameters by adjustingtheir estimates and refining methodologies. The incorporation of data from a period ofeconomic slowdown is particularly important for refining the analyses of the cyclical behaviorof credit risk. The effect on PD estimates and the credit conversion factor (CCF) is immediate.An analysis of the impact on LGD, however, depends on the maturity of the recoveryprocesses associated with those default events.Probability of default (PD)PD is a measure of credit rating that is assigned internally to a customer or a contract with theaim of estimating the probability of non-compliance within a year. It is obtained through a processusing scoring and rating tools.ScoringThese tools are statistical instruments designed to estimate the probability of defaultaccording to features of the contract-customer binomial. They are focused on managementof retail credit: consumer finance, mortgages, credit cards of individuals, corporate loans, etc.There are different types of scoring: reactive, behavioral, proactive and bureau.The main aim of reactive scoring is to forecast the credit quality of loan applicationssubmitted by customers. It attempts to predict the applicant’s probability of default if theapplication were accepted (applicants may or may not be BBVA customers at the time ofapplication).Credit risk93