Institutions should perform a robust analysis of the macro variables through descriptive statistics. At minimum, this analysis should examine, amongst others, the shape of distribution to identify outliers, shape of tails, multimodality. Upon this analysis, a clear statement should be made regarding the suitability of the data for macro modelling. In particular, the analysis should consider the data quality, length and representativeness. This analysis should be fully described in the model development documentation.
5.4.2
Regime shift: Institutions should identify the presence of regime shifts in all macro time series. Regime shifts can occur in macro time series due to economic decisions such as the introduction of VAT or a large shift in interest rates. Similarly to the dependent variables, macro time series with regime shifts should be avoided or adjusted accordingly.
5.4.3
Economic consistency: Institutions should pay attention to the economic significance of the macro variables. Some macro variables provide consistently better explanatory power of risk metrics in the banking book. Conversely some variables are more challenging to interpret, consequently institutions should be cautious when using those variables for PD and LGD macro models. Particular attention is needed for the following:
(i)
Employment rate: A large proportion of employees leave the UAE upon losing their employment. Consequently, the UAE employment rate incorporates a material bias, hence it is preferable to avoid this variable to model business or risk metrics.
(ii)
Interest rates: The relationship between interest rates and default rates is ambiguous. Institutions should ensure that an appropriate interpretation of the estimates is provided upon modelling PDs and LGDs.
(iii)
Abu Dhabi and Dubai stock indices: These indices can suffer from a lack of liquidity therefore institutions should ensure that an appropriate interpretation of the estimates is provided upon modelling PDs and LGDs.
(iv)
UAE account balances (e.g. fiscal balance, current account): By construction these variables can oscillate between positive and negative values. Consequently, a relative time differencing can lead to very high returns and uncontrollable spikes. Instead, it is recommended to normalise these variables by nominal GDP prior to using them for modelling.