CREDIT RISK MANAGEMENTTHE COMMODITISATION OF CREDIT RISKTRENDS IN CREDIT RISK MANAGEMENT
KEY PROPOSITION• THE ADVENT OF ACTIVE AND LIQUID CREDIT  TRADING WILL REQUIRE   – COMPLETE RE-ENGINEERING OF THE CREDIT   ...
AGENDA• KEY DRIVERS OF CHANGE• CREDIT RISK MANAGEMENT PARADIGMS   – CLASSICAL   – MODERN• CREDIT RISK MANAGEMENT ARCHITECT...
KEY DRIVERS OF CHANGE• KEY FEATURE OF CREDIT RISK   – CENTRAL TO ALL FINANCIAL TRANSACTIONS• TRADITIONAL VIEW OF CREDIT   ...
KEY DRIVERS OF CHANGE• SHAREHOLDER VALUE ISSUES   – RETURN ON CREDIT CAPITAL   – OPTIMISATION OF RETURN ON CREDIT     CAPI...
CAPITAL       RISK              PRODUCT/    TECHNOLOGY                                       KNOWLEDGE      MANAGEMENT   M...
KEY DRIVERS OF CHANGE• CREDIT RISK MANAGEMENT PERFORMANCE   – CONTROL FAILURES   – QUANTIFICATION OF CREDIT RISK   – INTER...
KEY DRIVERS OF CHANGE• COSTS OF CREDIT RISK MANAGEMENT  INFRASTRUCTURE• LIQUEFACTION OF CREDIT RISK   – SYNDICATION & ASSE...
KEY DRIVERS OF CHANGE• DEVELOPMENTS IN CREDIT ENHANCEMENT  TECHNIQUES   – BI-LATERAL   – MULTILATERAL• ADVANCES IN CREDIT/...
KEY DRIVERS OF CHANGE• CHANGE IN REGULATORY FRAMEWORK   – SHIFT TO CAPITAL BASED REGULATION   – REGULATORY ARBITRAGE   – (...
KEY DRIVERS OF CHANGE• KEY NEAR TERM FACTORS   – CREDIT CAPITAL MANAGEMENT   – CREDIT PRICING   – CREDIT RISK MANAGEMENT  ...
CREDIT RISK PARADIGMS• TYPES   – CLASSICAL   – MODERN• KEY ISSUE   – APPLICABILITY TO DIFFERENT MARKET     SEGMENTS
CREDIT RISK BY MARKET SEGMENT• SEGMENTS   – RETAIL   – MID-MARKET   – WHOLESALE/ CORPORATES• DIMENSIONS   – RISK   – PRICI...
LARGE                                  RETAIL NUMBER OF COUNTERPARTIES                                                  MI...
CLASSICAL PARADIGM• CONCEPT   – ASSESS RISK AND MATCH WITH CAPITAL   – RISK MANAGEMENT TECHNIQUES     • DIVERSIFICATION   ...
•CAPITAL                      •PROVISIONING       CREDIT RISK                                         MANAGEMENT          ...
CLASSICAL PARADIGM• KEY ELEMENTS• CREDIT ANALYSIS AND ASSESSMENT PROCESS
IMPLICATIONS OF CLASSICAL PARADIGM•   CREDIT RISK ASSUMPTION•   CREDIT PRICING•   CREDIT CAPITAL MANAGEMENT•   CREDIT RISK...
MODERN PARADIGM• CONCEPT   – CREDIT RISK AS A SEPARATE TRADEABLE     ASSET CLASS   – RISK MANAGED DYNAMICALLY THROUGH     ...
TRANSACTION                 •TRANSACTION                   ORIGINATION         ORIGINATION                            CLIE...
CREDIT RISK ASSUMED &                                                       MANAGED                                       ...
MODERN PARADIGM• KEY ELEMENTS• CREDIT ANALYSIS AND ASSESSMENT PROCESS
IMPLICATIONS OF MODERN PARADIGM•   CREDIT RISK ASSUMPTION•   CREDIT PRICING•   CREDIT CAPITAL MANAGEMENT•   CREDIT RISK FO...
IMPLICATIONS OF MODERN PARADIGM• CLIENT MANAGEMENT   – CORE VERSUS NON CORE CLIENTS   – HOME VERSUS FOREIGN MARKETS
CREDIT RISK MANAGEMENT ARCHITECTURE• CONCEPT   – RISK MANAGEMENT SYSTEMS COMPONENTS   – INFORMATION SYSTEMS• SCHEMATICS
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...
•CREDIT EXPOSURE - STATIC & DYNAMIC (PFCE MODEL)                        •DEFAULT PROBABILITY/ RATINGS MIGRATION           ...
IMPLICATIONS FOR FINANCIAL SERVICES• TYPES   – MICRO(OPERATIONAL)     • REDEFINITION OF CREDIT PROCESS WITHIN       ORGANI...
OPERATIONAL CHANGES• RE-ENGINEERING THE CREDIT PROCESS• ALTERATION OF CREDIT RISK ARCHITECTURE/  INFRASTRUCTURE
STRATEGIC CHANGES• THEME   – SHIFT FOCUS OF BANKS FROM HOLDER OF     RISK TO ORIGINATORS AND DISTRIBUTORS OF     RISK• MOD...
MODEL 1 - CLASSICAL BANKING MODEL           LOAN TRANSACTION                 DEPOSIT TRANSACTION                          ...
MODEL 2 - INVESTMENT BANKING/ SECURITIES MODEL               ISSUE OF SECURITIES                    DISTRIBUTION OF SECURI...
MODEL 3 - SECURITISATION MODEL                                                                  SALE OF LOAN BACKED       ...
MODEL 4 - ECONOMIC RISK TRANSFER MODEL            LOAN TRANSACTION                CREDIT DEFAULT SWAP OR                  ...
KEY CHALLENGES•   CREDIT RISK MODELLING PROBLEMS•   DEVELOPMENT OF CREDIT TRADING•   CREDIT ENHANCEMENT PROBLEMS•   CHANGE...
CONCLUSIONS• THE ADVENT OF ACTIVE AND LIQUID CREDIT  TRADING WILL REQUIRE   – COMPLETE RE-ENGINEERING OF THE CREDIT     FU...
Credit risk mgmt
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Credit risk mgmt

  1. 1. CREDIT RISK MANAGEMENTTHE COMMODITISATION OF CREDIT RISKTRENDS IN CREDIT RISK MANAGEMENT
  2. 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. 3. AGENDA• KEY DRIVERS OF CHANGE• CREDIT RISK MANAGEMENT PARADIGMS – CLASSICAL – MODERN• CREDIT RISK MANAGEMENT ARCHITECTURE• IMPLICATIONS FOR FINANCIAL SERVICES
  4. 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. 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. 6. CAPITAL RISK PRODUCT/ TECHNOLOGY KNOWLEDGE MANAGEMENT MANAGEMENT MANAGEMENT MANAGEMENT RISK ORIGINATION/ PRODUCT DISTRIBUTIONMANUFACTURE PROCESSING/ ADMINISTRATIONPRODUCT FOCUS CLIENT FOCUS
  7. 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. 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. 9. KEY DRIVERS OF CHANGE• DEVELOPMENTS IN CREDIT ENHANCEMENT TECHNIQUES – BI-LATERAL – MULTILATERAL• ADVANCES IN CREDIT/ DEFAULT RISK THEORY• INFRASTRUCTURE DEVELOPMENTS – SYSTEMS CAPABILITIES
  10. 10. KEY DRIVERS OF CHANGE• CHANGE IN REGULATORY FRAMEWORK – SHIFT TO CAPITAL BASED REGULATION – REGULATORY ARBITRAGE – (POSSIBILITY) OF MODEL BASED CREDIT RISK CAPITAL
  11. 11. KEY DRIVERS OF CHANGE• KEY NEAR TERM FACTORS – CREDIT CAPITAL MANAGEMENT – CREDIT PRICING – CREDIT RISK MANAGEMENT – REGULATORY DEVELOPMENTS – SHIFTS IN BANKING STRATEGY
  12. 12. CREDIT RISK PARADIGMS• TYPES – CLASSICAL – MODERN• KEY ISSUE – APPLICABILITY TO DIFFERENT MARKET SEGMENTS
  13. 13. CREDIT RISK BY MARKET SEGMENT• SEGMENTS – RETAIL – MID-MARKET – WHOLESALE/ CORPORATES• DIMENSIONS – RISK – PRICING – CREDIT METHODOLOGY – LIQUIDITY AND TRADEABILITY
  14. 14. LARGE RETAIL NUMBER OF COUNTERPARTIES MID-MARKET WHOLESALESMALL HIGH LOW SIZE OF INDIVIDUAL EXPOSURE
  15. 15. CLASSICAL PARADIGM• CONCEPT – ASSESS RISK AND MATCH WITH CAPITAL – RISK MANAGEMENT TECHNIQUES • DIVERSIFICATION • COLLATERAL• SCHEMATIC
  16. 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. 17. CLASSICAL PARADIGM• KEY ELEMENTS• CREDIT ANALYSIS AND ASSESSMENT PROCESS
  18. 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. 19. MODERN PARADIGM• CONCEPT – CREDIT RISK AS A SEPARATE TRADEABLE ASSET CLASS – RISK MANAGED DYNAMICALLY THROUGH HEDGING AND TRADING TOOLS• SCHEMATIC
  20. 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. 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. 22. MODERN PARADIGM• KEY ELEMENTS• CREDIT ANALYSIS AND ASSESSMENT PROCESS
  23. 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. 24. IMPLICATIONS OF MODERN PARADIGM• CLIENT MANAGEMENT – CORE VERSUS NON CORE CLIENTS – HOME VERSUS FOREIGN MARKETS
  25. 25. CREDIT RISK MANAGEMENT ARCHITECTURE• CONCEPT – RISK MANAGEMENT SYSTEMS COMPONENTS – INFORMATION SYSTEMS• SCHEMATICS
  26. 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. 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. 28. IMPLICATIONS FOR FINANCIAL SERVICES• TYPES – MICRO(OPERATIONAL) • REDEFINITION OF CREDIT PROCESS WITHIN ORGANISATIONS – MACRO(STRATEGIC) • REDEFINITION OF BUSINESS FOCUS
  29. 29. OPERATIONAL CHANGES• RE-ENGINEERING THE CREDIT PROCESS• ALTERATION OF CREDIT RISK ARCHITECTURE/ INFRASTRUCTURE
  30. 30. STRATEGIC CHANGES• THEME – SHIFT FOCUS OF BANKS FROM HOLDER OF RISK TO ORIGINATORS AND DISTRIBUTORS OF RISK• MODELS OF BANKING PRACTICE
  31. 31. MODEL 1 - CLASSICAL BANKING MODEL LOAN TRANSACTION DEPOSIT TRANSACTION DEPOSITORBORROWER BANK BANK ORIGINATES, FUNDS, ADMINISTERS AND RETAINS CREDIT RISK OF BORROWER
  32. 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. 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. 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. 35. KEY CHALLENGES• CREDIT RISK MODELLING PROBLEMS• DEVELOPMENT OF CREDIT TRADING• CREDIT ENHANCEMENT PROBLEMS• CHANGES IN CREDIT INFRASTRUCTURE• CHANGE MANAGEMENT
  36. 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
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