Validation methodology from HKMA CA-G-4

1. Validation of Rating discriminatory power：

−Cumulative Accuracy Profile (“CAP”) and itssummary index, the Accuracy Ratio (“AR”);−Receiver Operating Characteristic (“ROC”) and itssummary indices, the ROC measure and the PietraIndex;

−Bayesian error rate (“BER”);

−Conditional entropy, Kullback-Leibler distance, andConditional Information Entropy Ratio (“CIER”);

−Information value (“IV”);

−Kendall’s τ and Somers’ D (for shadow ratings);

−Brier score (“BS”); (this is similar to RMSE which we will do in validation)

−Divergence.

Not applicable since we will follow Basel’s rankingand our validation is not on discriminatory power.

2. Validation of PD calibration

−Binomial test with assumption of independentdefault events;

−Binomial test with assumption of non-zero defaultcorrelation;

−Chi-square test.

We will do this validation on the calibration, for the accuracy instead of conservative.

3. Validation of LGD estimates

−Comparisons between internal LGD estimatesand relevant external data sources This may not be applicable since currently in HK and PRC region, no bank has fully completed the IFRS9 modelling work, including HSBC. For bond, the external LGD has been used in IFRS9 model already.

−Comparisons between realised LGD of newdefaulted facilities and their LGD estimates We will do this.

4. Validation of EAD estimates

−back-test their internal EAD estimates against therealised EAD of the new defaulted facilities

We will do this for some segments which Basel EAD will be modified in IFRS9

−Where available, AIs should compare their internalestimates with external benchmarks.

This may not be applicable since currently in HK and PRC region, no bank has fully completed the IFRS9 modelling work, including HSBC.

−compare the estimated aggregate EAD amount forthe subject facility type with the realised aggregateEAD amount for that facility type

We will do this for some segments which Basel EAD will be modified in IFRS9

5. Benchmarking

−HKMA will expect AIs to obtain theirbenchmarks from third parties, provided that relevantexternal benchmarks for a specific portfolio areavailable. When external benchmarks are not used,despite being available, the HKMA will expect AIs toprovide valid justifications and demonstrate that theyhave other compensating measures