Issues in the credit risk modeling of retail markets

This paper surveys the most recent BIS proposals for the credit risk measurement of retail credits in capital regulations. It also describes the recent trend away from relationship lending toward transactional lending in the small business loan arena. These trends create the opportunity to adopt more analytical, data-based approaches to credit risk measurement. This study surveys proprietary credit scoring models (such as Fair Isaac) as well as options-theoretic structural models (such as KMV and Moody's RiskCalc), and reduced-form models (such as Credit Risk Plus). These models allow lenders and regulators to develop techniques that rely on portfolio aggregation to measure retail credit risk exposure. Retail credit markets offer special challenges to practitioners, regulators, and academics alike. Because of the special features of the retail market, one cannot analyze small retail loans by simply downsizing the models used to analyze large wholesale loans. This paper examines credit risk at the retail level.