Bank- und finanzwirtschaftliche Forschungen Band 392

Institut für Schweizerisches Institut für

schweizerisches Bankwesen Banken und Finanzen
der Universität Zürich an der Universität St. Gallen
Vahit Ferhan Benli

A Critical Assessment of
Basel II, Internal Rating
Based Approach
Implementation in Emerging Markets
The Case of Turkey

Haupt Verlag
Bern · Stuttgart · Wien
With 18 years of experience in the banking and finance sector in Turkey, Dr. Benli
presently manages financial and investment affairs of KILER Group of Companies,
a leading retail market group in Turkey. Born in 1966, in Turkey, Dr. V. Ferhan
Benli received his licence- and doctoral degrees from the University of Zürich-
Switzerland mainly in banking and Finance areas. He worked as Executive Vice
President for Financial Institutions and was Member of the Executive Committee
at Halkbank from 2003 to 2006. During his successful career he has managed to
finance a number of financial projects including the arrangement of a USD 1.8
Billion TUPRAS Deal and Euro 178 Million Ankara International Airport Project.
The two deals were elected as the “best acquisition finance in 2006” and as “best
project finance in 2005” in the world.

1. Auflage: 2010

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 ACKNOWLEDGEMENT
I would like to express my gratitude to Prof. Dr. Christine Hirszowicz for
her patience, encouragement and motivation. Also her commitment to
indoctrinating me, made this extracurricular project come true. Her understanding
of cultural discrepancies that emerged during the write-up phase of the project has
become an advantage for the writer. This cross borders passing project may not
have been realized without a superior mentor.

I am also deeply indebted to Prof Dr. Ernst Kilgus for giving me the vision to start
with the doctoral study in the early 90’s at the University of Zürich. The journey to
higher orbits of knowledge started with him. His teachings of bank management
will never ever be forgotten. In this regard, I would like to thank Prof. Dr. Hans
Geiger for all his constructive criticism during his seminars. I owe additional
gratitude to Prof. Hans Geiger for choosing this work as main referent and also for
coming to my defense for the written subject.

A life long “thank you” is extended to Prof. Dr. Rudolf Volkart, the Managing
Director of the Swiss Banking Institute. It was here that I learned the significance of
“cash flow” through a “Semesterarbeit” under his guidance during my freshman
years at the University of Zürich. He also taught us the true meaning of "the cost of
capital" . His teachings are always remembered at a time when the financial crisis
broke out in Turkey and we, as finance practitioners, went through bitter
experiences in a capital scarce country like Turkey.

Special thanks go to Dr. Dean Jovic for his friendship and inspirations combined
with great professionalism which he proved in reviewing the quantitative impact
analysis in Chapter 4. My sincere thanks go to Mr. Jack Gillespie, former Country
Head of ABN Amro Bank – Turkey, for teaching me the core elements of banking
practice, the art of leadership, and for his valuable feedback in reviewing the thesis.
On the other hand, a doctoral study needs more than know how, practice and
scientific knowledge. In this sense, my inspiration to learn the “truth” in a most
critical way and the cultural enlightenment to “write” and to “think” is given to me
by a world famous historian, Prof. Dr. Ilber Ortaylı.

This thesis would not have materialized without the illumination of Moody’s KMV
in London. In that regard, Chapter 6 is mainly dedicated to Mr. Gavin Style, former
Senior Managing Director and Mr. Robert O’Connor, Managing Director, for
generously giving me the precious chance to work closely with them, which
broadened my perspective in envisioning this difficult subject. My indebtedness is
addressed to my special wife Elif Banu, who made it possible for me to take time
off from work to make the thesis happen. My parents Fahrettin & Nedime both

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deserve a lifelong gratitude for encouraging me to complete the research since
almost a decade. In this sense, I do owe “last minitue” thanks to Mr. Ali Yilmaz for
revision and editing the text. Last but not least, how can I forward my thanks to my
brother Lic. iur. Mr. Murat Even, for keeping the “semester beitraege” duly paid
every single semester? My appreciation and thankfulness to all aforementioned
people and to my dearest uncle J. M. K goes beyond what can be put in simple
words.

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 Overview

Section I: Introduction to the Thesis and the Environmental Analysis of

Basel II from an Emerging Market Perspective

Chapter 1: Objectives and Structure of the Thesis

Chapter 2: The Emergence of Basel II in Turkey

Section II Analysis of the Basel II and the Quantitative Impact Studies

Chapter 3: The Path towards Basel II

Chapter 4: The Quantitative Impact Analysis of Basel II

Section III Implementation of the Basel II IRB Approaches

Chapter 5: Implementing the Internal Ratings-Based

Approach

Chapter 6: The Implementation of Basel II IRB with

Moody’s KMV Approach

Section IV Synthesis and Conclusions

Chapter 7: The synthesis of chapters 1-6 and conclusions

drawn from the thesis

Appendices Appendix I: Bibliography

Appendix II: Global Asset Correlation Factors

Appendix III: Example Data Details

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 Table of Contents
SECTION I: INTRODUCTION TO THE THESIS AND THE
ENVIRONMENTAL ANALYSIS OF BASEL II FROM AN EMERGING
MARKET PERSPECTIVE ......................................................................................... 14

1.1 Introduction ................................................................................................. 16

1.2 Scope and Objectives of the Thesis ................................................................. 18

1.3 Structure of the Thesis .................................................................................... 22

1.4 Methodology and Literature Review ............................................................... 23

CHAPTER 2: THE EMERGENCE OF BASEL II IN TURKEY ........................................ 28

2.1 Introduction .................................................................................................... 28

2.2 Role of the European Union’s Standards ....................................................... 30

2.3 Role of the IMF and World Bank as Supranational Anchors ......................... 34

2.4 Initial Progress towards Basel II: Banking Sector Restructuring Program ... 35

2.5 Basel II: Impact on the Corporate Banking Practices at Turkish Banks ........ 38

2.6 Basel II: Impact on the Financial Stability of Turkey ..................................... 40

2.7 Closing Remarks ............................................................................................. 42

SECTION II: ANALYSIS OF THE BASEL II ACCORD AND THE

QUANTITATIVE IMPACT STUDIES ..................................................................... 43

CHAPTER 3: THE PATH TOWARDS BASEL II ............................................................ 45

3.1 Introduction .................................................................................................... 46

3.2 Limitations of Basel I ...................................................................................... 47

3.3 Empirical Evidence about Bank Supervision, Regulation and Financial

Stability ................................................................................................................. 58

3.4 The New Basel Accord .................................................................................... 60

3.5 Closing Remarks on Basel II Accord .............................................................. 96

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 CHAPTER 4: THE QUANTITATIVE IMPACT ANALYSIS OF BASEL II ........................ 98

4.1 Introduction .................................................................................................... 98

4.2 Objectives of the Basel Committee’s Quantitative Impact Studies (QIS)........ 98

4.3 Third Quantitative Impact Study (QIS 3) ...................................................... 101

4.4 Quantitative Impact Study on Turkish Banks (QIS TR-1) ............................. 105

4.5 Closing Remarks to the Quantitative Impact Analysis of Basel II ................ 116

SECTION III: IMPLEMENTATION OF THE BASEL II IRB APPROACH 120

CHAPTER 5: IMPLEMENTING THE INTERNAL RATINGS-BASED APPROACH AND ITS

ORGANIZATIONAL FOUNDATIONS.......................................................................... 121

5.1 Introduction .................................................................................................. 122

5.2 Key Issues in Implementing the IRB ............................................................. 125

5.3 Organizational Backbone of Basel II Compliant Risk Management

Framework.......................................................................................................... 137

5.4 Group Risk Management (GRM) as the Final Decision Maker.................... 140

5.5 Risk Management Wholesale (RMW) ........................................................... 147

5.6 Loan Products Group (LPG) ........................................................................ 150

5.7 Closing Remarks to the Organizational Foundations of IRB Implementation

............................................................................................................................ 164

CHAPTER 6: THE IMPLEMENTION OF BASEL II IRB WITH MOODY’S KMV

(KEALHOFER, MACQUOWN AND VASICEK) APPROACH ........................................ 167

6.1 Introduction .................................................................................................. 167

6.2 Scope of Work ............................................................................................... 171

6.3 Phase 1: Bank-specific Gap Analysis ........................................................... 172

6.4 Phase 2: Data Foundation ............................................................................ 174

6.5 Phase 3: Risk Analyst as an Internal Rating System Platform...................... 179

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 6.6 Phase 4: Probability of Default (PD) Models............................................... 198

6.7 Phase 5: Single-Obligor Assessment Processes ........................................... 218

6.8 Phase 6: Development of an IRB Validation Framework ............................. 218

6.9 F-IRB Implementation Plan & Schedule ...................................................... 222

6.10 Phase 7: Use of External Models for Benchmarking .................................. 223

6.11 Phase 8: Road Map to A-IRB...................................................................... 225

6.12 Phase 9: Portfolio Analysis & Economic Capital Management ................. 227

6. 13 Overall Credit Risk Management Work Plan & Schedule ......................... 237

6.14 Closing Remarks to the Implementation of IRB with Moody’s KMV .......... 238

SECTION IV: SYNTHESIS AND CONCLUSIONS ............................................. 241

CHAPTER 7: THE SYNTHESIS OF THE CHAPTERS AND CONCLUSIONS DRAWN FROM

THE THESIS ............................................................................................................. 241

7.1 Emergence and Importance of Prudential Supervision and Financial Stability

............................................................................................................................ 242

7.2 Call for More Risk-sensitive Capital Measurement: Pillar 1 ....................... 247

7.3 Emergence and the Importance of the Link to Loss Given Default............... 249

7.4 Emergence and the Importance of Validation and Calibration .................... 250

7.5 Call for Better Supervisory Review Process and Additional Portfolio
Considerations: Pillar 2 ..................................................................................... 252

7.6 Call for Market Discipline and Transparency: Pillar 3 ............................... 255

7.7 The New Risk Management Organization: A Source of Competitive Advantage

............................................................................................................................ 257

APPENDICES ............................................................................................................ 259

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