The BBVA Group has developed a portfolio model in order to obtain a better economic capital metric for credit risk, taking into account the diversification and concentration effects inherent in its lending structure. This model provides BBVA with a key tool for credit risk management, which has been designed in line with the requirements of Pillar II of the Basel Accord.
The portfolio model considers that risk comes from various sources (it is a multi-factor model). This feature implies that economic capital is sensitive to geographic diversification, a crucial aspect in a global entity like BBVA. The tool is also sensitive to the possible concentration that may exist in certain credit exposures.
To sum up, the portfolio model includes the following effects:
- Geographic/industry concentration. This uses a matrix that penalizes correlations of assets for each segment/portfolio according to the size of the portfolio and the size of the economy in question.
- Individual concentration in the Group’s largest counterparties.
- Indirect concentration through the correlation between LGD and default.
The model enables impact analyses to be performed on the portfolios for the various factors causing concentration and diversification effects: the country/industry and individual counterparty concentration effect; the diversification effect between (geographic) factors and the random effect of LGD correlated to defaults.