05.2 credit quality monitoring

Copyright © 2018 CapitaLogic Limited
This presentation file is prepared in accordance with
Chapter 5 of the text book
“Managing Credit Risk Under The Basel III Framework, 3rd ed”
Website : https://sites.google.com/site/crmbasel
E-mail : crmbasel@gmail.com
Chapter 5
Credit Quality
Monitoring

Copyright © 2018 CapitaLogic Limited 2
Declaration
 Copyright © 2018 CapitaLogic Limited.
 All rights reserved. No part of this presentation file may be
reproduced, in any form or by any means, without written
permission from CapitaLogic Limited.
 Authored by Dr. LAM Yat-fai (林日辉),
Director, CapitaLogic Limited,
Adjunct Professor of Finance, City University of Hong Kong,
Doctor of Business Administration,
CFA, CAIA, CAMS, FRM, PRM.

Outline
 Individual borrowers monitoring
 Financial markets monitoring
 Large borrowers monitoring
 CapLogic SiFi credit index

Risk tolerance level
 Single debt
 The maximum EL which a lender can accept
 Determine through an experiment
 Debt portfolio
 The maximum XCL which a lender can accept
 Proxy by the maximum portfolio default loss in one year
 Every lender has his own subjective risk tolerance
level
Example 5.1

Credit assessment techniques
Credit assessment
External
(by independent
expert)
Corporate
credit rating
Internal
(by lender)
RetailCorporate
Retail
FICO score
Merton’s corporate
default model
Altman’s Z-score
Credit scoring
Credit scoring

External credit monitoring
 Corporate credit rating (> BBB)
 Moody’s, S&P, Fitch
 Retail FICO score (> 680)
 Individual persons
 TranUnion, Equifax, Experian
 SMEs
 Dun and Bradstreet

Internal credit monitoring
 Listed companies
 Merton’s corporate default model
 Altman’s Z-score
 Credit scoring
 Private firms
 Altman’s Z-score
 Credit scoring
 Individual persons and SMEs
 Credit scoring

Regular interest payments
 Before lending
 Up-to-date borrower information
 After lending
 Outdated borrower information
 Regular interest payments as a monitoring tool
 Monthly interest payments for retail lending
 Monthly, quarterly, semi-annual or annual interest
payments for corporate debts

Payroll accounts
 Borrower
 Open a savings account at the lending bank
 Register the savings account with employer for
monthly payroll collection
 Monthly salary deposited by employer to
payroll account on specific day monthly

Operating accounts
 Borrower
 Open an operating account at the lending bank
 Managing payrolls, payments, credit cards, mortgages, foreign
currencies, equities, funds
 All banking and investment transactions go through this
integrated account
 Monthly cash inflows and outflows recorded in
detail by the lender
 Excessive cash outflows over inflows triggers alerts
to the lender

External vs internal monitoring
External
 Advantages
 Leverage on external
expertise of credit
assessments
 Lower cost
 Disadvantages
 Only for borrowers with
credit ratings or FICO scores
 Usually updated on annual
basis or when there is a
major credit event
Internal
 Advantages
 Applicable to all borrowers
 Frequency controlled by
lender
 Tailored for different types
of borrowers
 Disadvantages
 Not a profit making activity
 Time consuming
 Expensive

Outline

Market based monitoring
 To monitor a manageable number of
systematic market monitoring factors (30 to
100) in a lender’s lending universe
 To take mitigation actions if systematic
market risk factors exhibit a confirmed trend
of deterioration

Systematic market
monitoring factors (1)
 Major currency rates
 USD, EUR, GBP, JPY, CNY
 Major interest rates
 Zero treasury rates
 Short term 1-year, medium term 5-year, longer
term 10-year

Systematic market
monitoring factors (2)
 Major equity market indices
 S&P500, DAX, CAC 40, FTSE, Nikkie 225, China SSE
 Major volatility indices
 S&P500, DAX, CAC 40, FTSE, Nikkie 225
 Major commodity prices
 Gold, oil
 Major credit indices
 CapLogic SiFi credit indices

Weekly percentage change
Market value
of monitoring factor
current week
= - 1 100%
Market value
of monitoring factor
previous week
 
 
 
 
 
 
 
  
 

 Early detection with change instead of levels
 What is this week’s percentage change relative to the
most recent business cycle (260 weeks) ?
 Emergency – extremities (+1%)
 Warning – wing regions (+1% to +5%)
 Attention – side regions (+5% to +10%)
 Normal – middle region (-10% to 10%)
 Snapshot analysis
 Trend analysis

Weekly percentage changes
80% = 4 year

Snapshot analysis
Example 5.2

Snapshot summary

Trend analysis

Outline

Large borrowers
 By EL
 Ten bank borrowers with the largest EL
 Ten non-bank borrowers with the largest EL
 By outstanding debt amount
 Ten bank borrowers with the largest outstanding
debt amount
 Ten non-bank borrowers with the largest
outstanding debt amount

Monitoring
 Weekly records of
 Credit rating
 FICO score
 CDS spread
 Trend analysis
 Financial news

Practical monitoring
Systematic credit quality Specific credit quality of large borrowers

Outline

Systematically important
financial institution (SiFi)
 A financial institution whose distress or
disorderly failure, because of its size,
complexity and systemic inter-connectedness,
would cause significant disruption to the
wider financial system and economic activity
 30 designated by Basel Committee and
Financial Stability Board
 To be reviewed annually in November

financial institutions (1)
North America
 Bank of America
 Bank of New York Mellon
 Citigroup
 Goldman Sachs
 JP Morgan Chase
 Morgan Stanley
 State Street
 Wells Fargo
Asia
 Mitsubishi UFJ FG
 Mizuho FG
 Sumitomo Mitsui FG
 Bank of China
 ICBC
 Agricultural Bank of China
 China Construction Bank

financial institutions (2)
UK and France
 Barclays
 HSBC
 Standard Chartered Bank
 Royal Bank of Scotland
 BNP Paribas
 Groupe Credit Agricole
 Groupe BPCE
 Société Générale
Rest of Europe
 Credit Suisse
 UBS
 Deutsche Bank
 ING Bank
 Nordea
 Santander
 Unicredit

CapLogic SiFi credit index
 Average of SiFis’ five-year CDS spreads
 Specifically designed for financial markets
monitoring
 No default effect, discontinuity or selection bias
 Very consistent and very little adjustment

05.2 credit quality monitoring

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