From Basel II to Basel III

Financial institutions face major challenges in modelling credit portfolio risk, particularly in the field of CDOs. Walter Schulte-Herbrüggen and Gernot Becker argue that the main challenge will be in model testing, due to the increasingly customised risk profiles attainable from these instruments

In June 2004, the revised framework, International Convergence of Capital Measurement and Capital Standards (Basel II), was ratified. In contrast to demand from the industry, a bank’s use of credit portfolio models was not admitted under Pillar 1. Nevertheless, under the internal capital adequacy assessment process of Pillar 2, portfolio models are permitted and implicitly required for sophisticated banks.1

While many participants in the banking industry were disappointed with this result, the