Quantitative Credit Metrics

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Quantitative Credit Metrics

  1. 1. RISK TRAINING SESSION#2/<br />19TH OF MAY 2010<br />QUANTITATIVE CREDIT METRICS<br />FOR:<br />DEPT . OF LOCAL INVESTMENTS<br />DONE BY: <br />QUANTITATIVE RISK ANALYTICS<br />TIIB – HEAD OFFICE <br />
  2. 2. BASEL II Pillar I : Capital Requirements <br /><ul><li>Standardized Approach
  3. 3. Internal Risk Based Approach
  4. 4. Advance Measurement Approach </li></li></ul><li>IRB Economic Capital Modeling <br /><ul><li>Under IRB the bank initially chooses to set economic capital as per :
  5. 5. Regulatory supervised standards (FIRB)</li></ul>(Foundation Approach )<br /><ul><li>Internally supervised standards (AIRB) </li></ul> (Advance Approach )<br />
  6. 6. FIRB <br />IRB ECONOMIC<br />CAPITAL MODELING<br />AIRB <br />
  7. 7. Quantifying Credit (Financing ) Risk Measurements as per BASEL 2 Accord:<br /><ul><li>LGD – (Loss Given Default)
  8. 8. EAD – (Exposure at Default)
  9. 9. PD - (Probability of Default)
  10. 10. RR - (Recovery Rate )
  11. 11. RP - (Repayment Probability)
  12. 12. EL - (Expected Loss)
  13. 13. UL - (Unexpected Loss)</li></li></ul><li>LGD – Loss Given Default :<br /><ul><li> LGD is calculated under IRB to calculate the maximum loss a bank may suffer if the customer defaults on the funded facility
  14. 14. LGD can be mathematically expressed as:</li></ul> LGD% = (1- Recovery Rate%)<br />
  15. 15. LGD = (1- Recovery Rate) Example :<br /><ul><li>Bank ABClends YR 100 Mio to a an XYZ industry in Tiez .
  16. 16. The total value of the collateral (RAHN)</li></ul> stands at YR 75 Mio .<br /><ul><li>What will be the LGD in case of Default ?
  17. 17. (1 -0.75) = (0.25) 25 %
  18. 18. 0.25 * YR 100 Mio = 25 Mio </li></li></ul><li>EAD – Exposure at Default :<br /><ul><li> Total Amount recorded in book value terms as financing (credit) which is exposed to default risk
  19. 19. This normally is earmarked by banks in market value terms as FPE – (Future Potential Exposure) adjusted for changes in present value and inflationary terms over time</li></li></ul><li>EAD – Exposure at Default (Example) :<br /><ul><li>If the bank provides a master borrowing line of YR 300 Mio to an xyz customer, and drawdown is 10%; what will be the bank’s total EAD in YR - Yemeni Rial ?
  20. 20. EAD = Total Line * Drawdown Rate </li></ul> = YR 300 Mio * 0.10 = 30 Mio <br />
  21. 21. PD – (Probability of Default ) :<br /><ul><li>Probability of default is a measure of default in percentage terms
  22. 22. Probability of Default can be inferred from the credit score assigned by the analyst
  23. 23. Probability of Default changes over business cycles for all customers</li></li></ul><li>PD – (Probability of Default ) (Example) :<br /><ul><li> We can use various models to calculate PD
  24. 24. PD can be computed using LOGIT Model
  25. 25. For example if internal risk rating assigned to a bank customer by local investments is 2 , what will be the PD ?
  26. 26. PD = 1/ (1+exp ^(-zi))
  27. 27. PD = 1/(1+ exp ^(-2))
  28. 28. = 88%</li></li></ul><li>RR – Recovery Rate :<br /><ul><li>Recovery rate gives you in percentage terms the amount which a bank may be able to recover/collect after liquidation of RAHN (security) against the loan as part of Remedial Management Strategy</li></li></ul><li>RR – Recovery Rate (Example) :<br /><ul><li>If the bank assigns a financing facility to a client with a LGD of 45% , what will be the RR?
  29. 29. RR% = (1- LGD)</li></ul> = (1-0.45)<br /> = 55.0%<br />
  30. 30. RP – (Repayment Probability):<br /><ul><li> The Repayment Probability of the amount which the bank expects from its client to be repaid
  31. 31. It gives us the measure of customer solvency at the initiation stage of the financing transaction</li></li></ul><li>RP – (Repayment Probability) (Example):<br /><ul><li>If the bank customer has a PD (Probability of Default ) of 5% , than what is the RP ?
  32. 32. RP = (1-PD)</li></ul> = (1- 0.05)<br /> = 95%<br />
  33. 33. EL – (Expected Loss) :<br /><ul><li>Is the average amount which the bank expects to lose due to default outcome !
  34. 34. EL is mathematically expressed as :
  35. 35. EL = Probability of Default * Loss Given Default </li></li></ul><li>EL – (Expected Loss) (Example) :<br /><ul><li>IF PD is 5.00% and LGD is 11.00% ; what will be EL ?
  36. 36. EL = PD* LGD </li></ul> = 25%*11%<br /> = 2.75% <br />
  37. 37. UL – (Unexpected Loss) :<br /><ul><li>Unexpected Loss is the amount which a bank may lose unexpectedly.
  38. 38. UL (Unexpected Loss) is the volatility of losses around EL (Expected Loss)
  39. 39. Bank needs to use risk capital / economic capital to hedge against this type of financial risk phenomena</li></li></ul><li>UL – (Unexpected Loss) (Example) :<br /><ul><li>If the bank has an expected loss of 10% , what will be it’s UL ?
  40. 40. UL = (1- EL)</li></ul>= (1- 0.10)<br /> = 90%<br />

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