- **Calibration issues** . To what extent the Pillar 1 is properly calibrated is an issue for supervisors of non-G10 countries, whose loss experience has not been systematically taken into consideration in the architecture of the capital framework.

In the case of the simpler, standardized approach, regulators and supervisors will most likely need to revise aspects such as the definition of the regulatory retail portfolio. This is particularly true for small and medium enterprises (SMEs), in which they will be treated as retail borrowers and therefore will receive a lower risk weight than corporate obligors. Also the suitability of the supervisory risk weights will need to be reviewed. Risk weights of 35% and 75% for residential mortgages and retail credits (including eligible SMEs) may be unrealistically low in some jurisdictions. Loan default and recovery data stored in PCRs would allow the regulators to assess if the loss experience in these credits would warrant that those risk weights should be increased.

Recalibrating the IRB model is a fairly more complex and controversial issue because it implies deviating from the new standard in regulatory capital. Policymakers must nevertheless bear in mind that its parameters were adjusted to ensure that, when applied to G10 banks, IRB results (i.e. unexpected losses) are similar to those obtained from conventional credit portfolio models. However, that may not be the case when applied to emerging markets banks. Therefore, the impact of the systematic factor on borrowers’ creditworthiness (asset correlation), the suitability of the SME definition, the adjustment in capital requirements for credits with long maturities and the convenience of using a different confidence level (compared to the standard 99.9%) are issues that may need be reconsidered by local authorities. This could complicate and lengthen the adoption of the Revised International Capital Framework. For example, using bootstrapping<sup>30</sup> techniques Majnoni _et al_ (2004b) and Gutierrez Girault (2007) find evidence indicating that the IRB formula for corporate obligors may not be properly calibrated to unexpected losses in commercial portfolios of banks in certain Latin American countries. With data from the Argentine PCR, Balzarotti _et al_ (2004) revised how the IRB model might be recalibrated to ensure it appropriately covers credit risk losses.

- **Validation** . Supervisors of banks adopting the IRB approach are expected to revise the internal validation of bank rating systems. This revision has a qualitative dimension, focused on data quality and rating system use, design and documentation, and a quantitative dimension to assess their predictive power. In the latter case, and by means of statistical tests (e.g. the Kolmogorov-Smirnov test), graphical tools (e.g. the Cumulative Accuracy Profile or ROC curve) and database programming, supervisors can validate these systems with the credit information stored at their PCR. Their results can be used to evaluate how the discriminatory power of a bank rating system evolves through a business cycle, or if different bank’s rating systems concerning the same type of portfolio display a significantly different predictive power. PCRs can also be helpful to validate banks’ estimates of other risk dimensions required by the IRB. In some countries

> 30 Given a real portfolio of borrowers that displays certain loss rate, thousands of hypothetical portfolios are simulated drawing randomly with replacement borrowers from the real portfolio. For each simulated portfolio a loss rate is computed. The resulting simulated loss rates are an empirical approximation to the distribution of the loss rate for that type of portfolio.

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