Annotation to BASEL II
Basel II leads to significant changes in the business of financial institutions. Apart from risk management questions there is also the important issue of the adaptation of the bank's software. Without appropriate IT- methods the Basel II regulations would be a great burden for banks and they would entail continuously high operating expenses.The adaptation of software and data management should take place at an early stage because at the time of the introduction of Basel II the financial institutes are expected to dispose of an adequate and significant data base.
The new Basel Accord accord lays stress on the risk/reward trade-off for capital. The capital requirements for risk capital will be calculated depending on the risk of default and depending on the expected loss. Collateral will be an important means of risk mitigation.
The basics of the calculation are on the one hand the probability of default of the borrower (PD), as well as the residual maturity of the credit - and on the other hand the exposure at default (EAD) and the loss given default (LGD) of the amount of credit not covered by collateral.
Collateral will be an important means of risk mitigation, but the regulations will be complex. One of the problems is to match and assign collateral to loans and to determine the optimal structure of priorities for large credit exposures.
If financial institutions would calculate the priorities for collateralization solely on the basis of the Basel II rules, they would not obtain an optimal result. Large exposures are networks - often with a high degree of interdependence of all parts involved in these exposures. In such cases the overall result would only be improved if the basic characteristics of distributions in networks are also considered. Our optimization method is capable of dealing with these fundamental features, and that is the reason why our optimization method really calculates the optimal collateralization, i.e. the optimum for each complete credit exposure.