Credit risk management

1. Copyright © 2018 CapitaLogic Limited
Chapter 16
The IFRS 9
This presentation file is prepared in accordance with
Chapter 16 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

2. 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.

3. The IFRS 9
 An accounting framework set out by the
International Accounting Standards Board
 To address the major accounting issues of
financial instruments through a set of unified
practices
 Applicable to major financial instruments
 To ensure the level playing field among
financial institutions
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4. Copyright © 2018 CapitaLogic Limited 4
Outline
 Book value
 Credit provision and interest income

5. Price and value
 Price
 The amount of cash that
 Somebody is willing to receive for selling
 Somebody is willing to pay for buying
 Value
 The amount of cash to be received, assuming that
immediately
 Somebody will receive for selling
 Somebody will pay for buying
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6. Market value
 Market value = Market price
 For a financial instrument traded liquidly in
the market
 Assuming that the current holding of an
equity can be disposed in the very near future
at the same price
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7. Model value
 Value calculated by a quantitative model
 with some independent variables observable directly
or indirectly from the market
 On-the-run US treasuries
 Of-the-run US treasuries
 Discount rate = IRR
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 
 
N
N
k
k=1
N
N
k
k=1
IRR
Model
CF
Market price =
1 +
CF
=
1 + Discount rat
val e
e
u



8. Credit risky debts
 No liquid trading market
 No market price
 Market value not applicable
 No market price of similar debt
 IRR cannot be derived
 Model value not applicable
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9. Book value
 Value calculated by the IFRS 9 rules
 Loan
 Book value = Outstanding principal
 Corporate bond acquired at principal
 Book value = Principal
 Book IRR
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Interest rate
Book IRR =
Interest frequency

10. Premium/discount corporate bond
 Book IRR
 Book value
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 
 
N
N
k
k=1
1 2 3 N
0
1
CF
Acquisition cost =
1 + Book IRR
Book IRR = IRR -Acquisition cost, CF , CF , CF , ... CF
Interest rate
Interest amount = Principal ×
Interest frequency
Book value = Acquisition cost
Book value =

 
 
 
0
2 1
k k-1
Book value × 1 + Book IRR - Interest amount
Book value = Book value × 1 + Book IRR - Interest amount
Book value = Book value × 1 + Book IRR - Interest amount
Example 16.2
Example 16.1

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Outline
 Book value
 Credit provision and interest income

12. Present value of expected loss
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 
   k-1 k
k k
T T
k
k k
Default loss = EAD × LGD
Interest rate
= Principal × 1 + × LGD
Interest frequency
1
Discount factor =
1 + Book IRR
Default chance = 1 - PD - 1 - PD
PVEL = Default loss × Discount factor × D
 
 
 
k
N
k
k=1
efault chance
Total PVEL = PVEL

13. Credit provision
 Lower credit risk at origination
 General provision = 1-year PVEL
 Cost has incorporated the prevailing credit risk
 Moderate credit risk
 General provision = RM-year PVEL
 Cost has NOT incorporated the additional credit risk
 Higher credit risk
 Specific provision = RM-year PVEL
 Cost has NOT incorporated the additional credit risk
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14. Interest income
 Lower credit risk at origination
 Book value × Book IRR
 Moderate credit risk
 Book value × Book IRR
 Higher credit risk
 (Book value - Specific provision) × Book IRR
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Example 16.3

15. Extensions
 CDOs and government bonds
 intended to be held until maturity
 similar cash flow pattern
 Model value
 Credit provision
 Interest income
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