Credit risk mgmt
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  • 1. CREDIT RISK MANAGEMENTTHE COMMODITISATION OF CREDIT RISKTRENDS IN CREDIT RISK MANAGEMENT
  • 2. KEY PROPOSITION• THE ADVENT OF ACTIVE AND LIQUID CREDIT TRADING WILL REQUIRE – COMPLETE RE-ENGINEERING OF THE CREDIT FUNCTION & PROCESS – ALTER THE NATURE OF BANKING FUNDAMENTALLY
  • 3. AGENDA• KEY DRIVERS OF CHANGE• CREDIT RISK MANAGEMENT PARADIGMS – CLASSICAL – MODERN• CREDIT RISK MANAGEMENT ARCHITECTURE• IMPLICATIONS FOR FINANCIAL SERVICES
  • 4. KEY DRIVERS OF CHANGE• KEY FEATURE OF CREDIT RISK – CENTRAL TO ALL FINANCIAL TRANSACTIONS• TRADITIONAL VIEW OF CREDIT – ILLIQUID• CURRENT VIEW OF CREDIT – LIQUID & TRADEABLE• SHIFT FROM STATIC MANAGEMENT OF CREDIT TO DYNAMIC MANAGEMENT OF CREDIT RISK
  • 5. KEY DRIVERS OF CHANGE• SHAREHOLDER VALUE ISSUES – RETURN ON CREDIT CAPITAL – OPTIMISATION OF RETURN ON CREDIT CAPITAL• CHANGES IN FINANCIAL SERVICES – VALUE CHAIN IN FINANCIAL SERVICES – TREND TO UNBUNDLING THE MICROSTRUCTURE
  • 6. CAPITAL RISK PRODUCT/ TECHNOLOGY KNOWLEDGE MANAGEMENT MANAGEMENT MANAGEMENT MANAGEMENT RISK ORIGINATION/ PRODUCT DISTRIBUTIONMANUFACTURE PROCESSING/ ADMINISTRATIONPRODUCT FOCUS CLIENT FOCUS
  • 7. KEY DRIVERS OF CHANGE• CREDIT RISK MANAGEMENT PERFORMANCE – CONTROL FAILURES – QUANTIFICATION OF CREDIT RISK – INTERACTION OF MARKET AND CREDIT RISK• CREDIT RISK PRICING – INABILITY TO PRICE CREDITR ISK “CORRECTLY” – INCONSISTENCY OF PRICING
  • 8. KEY DRIVERS OF CHANGE• COSTS OF CREDIT RISK MANAGEMENT INFRASTRUCTURE• LIQUEFACTION OF CREDIT RISK – SYNDICATION & ASSET SALES – SECURITISATION – CREDIT DERIVATIVES & CREDIT LINKED NOTES
  • 9. KEY DRIVERS OF CHANGE• DEVELOPMENTS IN CREDIT ENHANCEMENT TECHNIQUES – BI-LATERAL – MULTILATERAL• ADVANCES IN CREDIT/ DEFAULT RISK THEORY• INFRASTRUCTURE DEVELOPMENTS – SYSTEMS CAPABILITIES
  • 10. KEY DRIVERS OF CHANGE• CHANGE IN REGULATORY FRAMEWORK – SHIFT TO CAPITAL BASED REGULATION – REGULATORY ARBITRAGE – (POSSIBILITY) OF MODEL BASED CREDIT RISK CAPITAL
  • 11. KEY DRIVERS OF CHANGE• KEY NEAR TERM FACTORS – CREDIT CAPITAL MANAGEMENT – CREDIT PRICING – CREDIT RISK MANAGEMENT – REGULATORY DEVELOPMENTS – SHIFTS IN BANKING STRATEGY
  • 12. CREDIT RISK PARADIGMS• TYPES – CLASSICAL – MODERN• KEY ISSUE – APPLICABILITY TO DIFFERENT MARKET SEGMENTS
  • 13. CREDIT RISK BY MARKET SEGMENT• SEGMENTS – RETAIL – MID-MARKET – WHOLESALE/ CORPORATES• DIMENSIONS – RISK – PRICING – CREDIT METHODOLOGY – LIQUIDITY AND TRADEABILITY
  • 14. LARGE RETAIL NUMBER OF COUNTERPARTIES MID-MARKET WHOLESALESMALL HIGH LOW SIZE OF INDIVIDUAL EXPOSURE
  • 15. CLASSICAL PARADIGM• CONCEPT – ASSESS RISK AND MATCH WITH CAPITAL – RISK MANAGEMENT TECHNIQUES • DIVERSIFICATION • COLLATERAL• SCHEMATIC
  • 16. •CAPITAL •PROVISIONING CREDIT RISK MANAGEMENT •RISK SYNDICATION CREDIT REQUEST TRANSACTION CREDIT ORIGINATION CLIENT FUNCTION CREDIT LIMIT •TRANSACTION ORIGINATION•CREDIT ASSESSMENT •PREPARATION OF CREDIT•MONITORING CREDIT LIMIT & REQUESTCREDIT ADMINISTRATION •PRICING/ STRUCTURING •ADMINISTRATION
  • 17. CLASSICAL PARADIGM• KEY ELEMENTS• CREDIT ANALYSIS AND ASSESSMENT PROCESS
  • 18. IMPLICATIONS OF CLASSICAL PARADIGM• CREDIT RISK ASSUMPTION• CREDIT PRICING• CREDIT CAPITAL MANAGEMENT• CREDIT RISK FOCUS• CHANGES IN CREDIT QUALITY• PERFORMANCE ATTRIBUTION OF ORIGINATORS• PERFORMANCE OF CREDIT FUNCTION
  • 19. MODERN PARADIGM• CONCEPT – CREDIT RISK AS A SEPARATE TRADEABLE ASSET CLASS – RISK MANAGED DYNAMICALLY THROUGH HEDGING AND TRADING TOOLS• SCHEMATIC
  • 20. TRANSACTION •TRANSACTION ORIGINATION ORIGINATION CLIENT •STRUCTURING/ PRICING CREDIT CREDIT LIMIT & •ADMINISTRATION REQUEST CREDIT CHARGE CREDIT FUNCTION •CREDIT ASSESSMENT •SYNDICATION/ •CREDIT ASSET SALES PORTFOLIO CREDIT •SECURITISATION CREDIT ANALYSIS TRADING PORTFOLIO CREDIT PORTFOLIO •CREDIT •CREDIT DERIVATIVES MANAGEMENT & POSITIONING CAPITALMANAGEMENT CREDIT CAPITAL CAPITAL MARKET
  • 21. CREDIT RISK ASSUMED & MANAGED CREDIT CAPITAL TRANSACTION INTERNAL CREDIT CREDIT RISK DEFAULT SWAP CREDIT RISK CREDITTRANSACTION ORIGINATOR PORTFOLIO RETURN CREDIT RISK CHARGE CREDIT HEDGES CREDIT RISK TRADED & HEDGED
  • 22. MODERN PARADIGM• KEY ELEMENTS• CREDIT ANALYSIS AND ASSESSMENT PROCESS
  • 23. IMPLICATIONS OF MODERN PARADIGM• CREDIT RISK ASSUMPTION• CREDIT PRICING• CREDIT CAPITAL MANAGEMENT• CREDIT RISK FOCUS• CHANGES IN CREDIT QUALITY• PERFORMANCE ATTRIBUTION OF ORIGINATORS• PERFORMANCE OF CREDIT FUNCTION
  • 24. IMPLICATIONS OF MODERN PARADIGM• CLIENT MANAGEMENT – CORE VERSUS NON CORE CLIENTS – HOME VERSUS FOREIGN MARKETS
  • 25. CREDIT RISK MANAGEMENT ARCHITECTURE• CONCEPT – RISK MANAGEMENT SYSTEMS COMPONENTS – INFORMATION SYSTEMS• SCHEMATICS
  • 26. C R E D IT R IS K M A N A G E M E N T A R C H IT E C T U R EC R E D IT A N A L Y S IS C R E D IT P O R T F O L IO M O D E L L IN G / C R E D IT T R A D IN G C R E D IT P R IC IN G C R E D IT C A P IT A L M A N A G E M E N T E C O N O M IC C A P IT A L R E G U L A T O R Y C A P IT A L C R E D IT E N H A N C E M E N T C R E D IT A D M IN IS T R A T IO N C R E D IT S Y S T E M S / IT IN F R A S T R U C T U R E
  • 27. •CREDIT EXPOSURE - STATIC & DYNAMIC (PFCE MODEL) •DEFAULT PROBABILITY/ RATINGS MIGRATION •RECOVERY RATES •DEFAULT CORRELATIONS •PORTFOLIORATING MODELS MODELS •INTERNAL CREDIT CREDIT RISK DATA •PRICING ANALYSIS MODELS •EXTERNAL MODELS TRANSACTION DATA CREDIT •COLLATERAL OBLIGOR/ DATA CREDIT •NETTING COUNTERPARTY ENHANCEMENT •CLEARING DATA HOUSE •ECONOMIC CAPITAL CREDIT•REGULATORY LIMIT CAPITAL ADMINISTRATION CAPITAL MANAGEMENT•PROVISIONING REPORTING •SETTLEMENT LIMITS •RISK LIMITS
  • 28. IMPLICATIONS FOR FINANCIAL SERVICES• TYPES – MICRO(OPERATIONAL) • REDEFINITION OF CREDIT PROCESS WITHIN ORGANISATIONS – MACRO(STRATEGIC) • REDEFINITION OF BUSINESS FOCUS
  • 29. OPERATIONAL CHANGES• RE-ENGINEERING THE CREDIT PROCESS• ALTERATION OF CREDIT RISK ARCHITECTURE/ INFRASTRUCTURE
  • 30. STRATEGIC CHANGES• THEME – SHIFT FOCUS OF BANKS FROM HOLDER OF RISK TO ORIGINATORS AND DISTRIBUTORS OF RISK• MODELS OF BANKING PRACTICE
  • 31. MODEL 1 - CLASSICAL BANKING MODEL LOAN TRANSACTION DEPOSIT TRANSACTION DEPOSITORBORROWER BANK BANK ORIGINATES, FUNDS, ADMINISTERS AND RETAINS CREDIT RISK OF BORROWER
  • 32. MODEL 2 - INVESTMENT BANKING/ SECURITIES MODEL ISSUE OF SECURITIES DISTRIBUTION OF SECURITIES INVESTORBORROWER BANK UNDERWRITING OF PLACEMENT OF SECURITIES AND SYNDICATION OF UNDERWRITING RISK OTHER BANKS BANK ORIGINATES TRANSACTION AND MAY ADMINISTER IT AS PAYMENT AGENT. FUNDING AND CREDIT RISK OF BORROWER IS TRANSFERRED TO INVESTOR. PRIMARY RISK IS UNDERWRITING WHICH IS SYNDICATED TO REDUCE RISK LEVEL,
  • 33. MODEL 3 - SECURITISATION MODEL SALE OF LOAN BACKED LOAN TRANSACTION SECURITIES SECURITISATIONBORROWER BANK INVESTOR VEHICLE SALE OF LOAN TO SECURITISATION VEHICLE BANK ORIGINATES AND ADMINISTERS THE LOAN. BANK SELLS LOAN TO SECURITISATION VEHICLE WHICH ISSUES LOAN ASSET BACKED SECURTIES. FUNDING AND CREDIT RISK OF BORROWER IS BORNE BY INVESTOR. BANK RISK IS CONFINED TO CREDIT RISK PRE-SALE TO SECURITISATION VEHICLE AND ANY UNDERWRITING RISK ON THE PLACEMENT OF THE LOAN ASSET BACKED SECURITIES
  • 34. MODEL 4 - ECONOMIC RISK TRANSFER MODEL LOAN TRANSACTION CREDIT DEFAULT SWAP OR CREDIT LINKED NOTE INVESTOR/BORROWER BANK OTHER BANK BANK ORIGINATES, FUNDS AND ADMINISTERS THE LOAN. CREDIT RISK OF BORROWER IS TRANSFERRED TO INVESTORS OR OTHER BANKS. BANK CREDIT RISK IS PRE ECONOMIC HEDGE ONLY. WHERE A CREDIT LINKED NOTE IS ISSUED THE INVESTOR/ OTHER BANK ALSO PROVIDES FUNDING.
  • 35. KEY CHALLENGES• CREDIT RISK MODELLING PROBLEMS• DEVELOPMENT OF CREDIT TRADING• CREDIT ENHANCEMENT PROBLEMS• CHANGES IN CREDIT INFRASTRUCTURE• CHANGE MANAGEMENT
  • 36. CONCLUSIONS• THE ADVENT OF ACTIVE AND LIQUID CREDIT TRADING WILL REQUIRE – COMPLETE RE-ENGINEERING OF THE CREDIT FUNCTION & PROCESS – ALTER THE NATURE OF BANKING FUNDAMENTALLY