This document discusses credit concentrations and the importance of identifying, monitoring, measuring, and controlling related risks. It provides examples of how loans can be grouped into pools based on similar risk characteristics and aggregated if certain conditions are met. The document also outlines house and portfolio limits established by the bank's board to control concentration risk and discusses the value of stress testing and robust management information systems in mitigating risk.
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Safeguard your lending program by learning about the 8 steps of credit risk management. Learn about nonfinancial risks, structuring the loan, and more.
Information on the five C's of credit, bankruptcy proceedings, credit policy, credit investigations, credit fraud, credit decisions, customer visits, the sales department, and the vredit department.
The system of organized lending can never run out of risks. Be market, liquidity, credit, interest or operational, risk is inevitable for banks and other financial firms.
Hence, a primary importance is given to risk profiling in all financial institutions.
One of the omnipresent risks that have taken a toll on banks regularly is credit risk. In simplest terms, this risk can be defined as non repayment of a loan as per agreed conditions, to the lender, thus ruining the lender’s investment.
The non repayment can be intentional (willful default), due to failure of an industry (systemic risk), failure of cross currency settlement (settlement risk) etc.
In this article, we are going to explore credit risk. We will discuss its basic meaning, types, causes, effects and how banks all over the world have made attempts to monitor, mitigate, transfer and at times, accept the risk.
A great primer on Financial Restructurings prepared by Valerio Ranciaro, General Director from SACE, covering everything you need to know from analyzing the capital structure of a company, to the procedures in financial restructure, to a case study of the restructuring of Telecom Argentina.
Safeguard your lending program by learning about the 8 steps of credit risk management. Learn about nonfinancial risks, structuring the loan, and more.
Information on the five C's of credit, bankruptcy proceedings, credit policy, credit investigations, credit fraud, credit decisions, customer visits, the sales department, and the vredit department.
The system of organized lending can never run out of risks. Be market, liquidity, credit, interest or operational, risk is inevitable for banks and other financial firms.
Hence, a primary importance is given to risk profiling in all financial institutions.
One of the omnipresent risks that have taken a toll on banks regularly is credit risk. In simplest terms, this risk can be defined as non repayment of a loan as per agreed conditions, to the lender, thus ruining the lender’s investment.
The non repayment can be intentional (willful default), due to failure of an industry (systemic risk), failure of cross currency settlement (settlement risk) etc.
In this article, we are going to explore credit risk. We will discuss its basic meaning, types, causes, effects and how banks all over the world have made attempts to monitor, mitigate, transfer and at times, accept the risk.
A great primer on Financial Restructurings prepared by Valerio Ranciaro, General Director from SACE, covering everything you need to know from analyzing the capital structure of a company, to the procedures in financial restructure, to a case study of the restructuring of Telecom Argentina.
Mercer Capital's Bank Watch | August 2019 | Community Bank Valuation (Part 2)Mercer Capital
Brought to you by the Financial Institutions Team of Mercer Capital, this monthly newsletter is focused on bank activity in five U.S. regions. Bank Watch highlights various banking metrics, including public market indicators, M&A market indicators, and key indices of the top financial institutions, providing insight into financial institution valuation issues.
General Principles of Lending:
When a request for a loan is received, it is important to ensure that the borrower has the legal capacity to borrow. The other matters upon which the information should be obtained are: the purpose of advance, the amount involved, the duration of the advance, the sources of repayment, the profitability of transaction, and, where applicable, the security offered. The most fundamental principle of all is that the bank should have confidence in the integrity, competence and continuing credit worthiness of the borrower.
• Know Your Customer:
While entertaining a proposal for advance, the branch has to first ensure compliance with the KYC norms.
• Pre- Sanction Stage:
Obtain/compile the following:
• Bio-data/declaration of assets owned by the borrower and guarantor along with latest income tax/wealth tax assessment copies and compilation of opinion reports.
• Particulars of immediate family members/legal heirs along with their father’s name and age.
• Audited balance sheets for the previous 3 years, estimated balance sheet for the current year and projected balance sheet for the next year.
• Particulars of existing borrowing arrangements and credit reports/no objection letters from existing banks if any.
• It should be followed by independent verification by the branch incumbent.
• Details of associate/group concerns, their borrowing arrangements and their latest balance sheets.
• No objection letter from term loan lender(s) if already financed by them and their permission/willingness to cede pari passu/ second charge on their security.
• The position of term working capital liabilities with various banks/FIs and details thereof viz., Limit, DP, Out standings, Irregularities (if any).
• Conduct a search/obtain a search report from Registrar of Companies to ascertain position of charges created already.
•
• Due Diligence:
• Branch Manager should do adequate Due Diligence before bringing an asset to the Bank’s books. This will avoid NPA.
• Thorough inquiry about the prospective borrower (with other banks, Financial Institutions, etc.) market intelligence, his past track record of performance and repayment of obligations, credit worthiness (Net Worth) must be done.
• Personal visit to his office/place of business will give an idea of his business.
• Processing of Applications:
While processing the applications, the following should be looked into and commented upon in the proposal:
• Due diligence on promoters’ background, their track record of repayment by checking with their existing bankers (NPA status) (any rephasements, any compromise entered into), credit worthiness, market reputation etc.
• Latest RBI defaulters’ list and willful defaulters' list —Company and their Directors.
• Bank’s loan policy.
• Contractual capacity of the borrower regarding borrowing powers/any restrictions on borrowings and names of persons authorized to borrow by verifications of:
• Partnership deed
HVCRE (high volatility commercial real estate): A PrimerLibby Bierman
In this webinar from Sageworks we cover the definition of High Volatility Commercial Real Estate (HVCRE) and best practices for mitigating concentration risk at banks and credit unions. Access this and other webinars at https://www.sageworks.com/banking/resources/bank-webinars/
In a recent poll, 42% of bankers indicated that commercial real estate is the primary focus for growth in the loan portfolio. At the same time, regulators are concerned that CRE may be overheating as lending standards have eased and CRE portfolios have experienced significant growth.
Week-9 Bank RegulationMoney and Banking Econ 311Tuesdays 7 .docxalanfhall8953
Week-9 Bank Regulation
Money and Banking Econ 311
Tuesdays 7 - 9:45
Instructor: Thomas L. Thomas
Capital Adequacy Management
Bank capital helps prevent bank failure
The amount of capital affects return for the owners (equity holders) of the bank
Regulatory requirement – Regulatory Capital – Tier 1 and Tier 2 Basle Rules
Economic Capital - What is this
2
Capital Adequacy Management:
Returns to Equity Holders
3
Traditional Economic Capital Value-At-Risk (VaR) View
Frequency of Occurrence / Probability
Mean/Average Expected Losses (m)
Unexpected Losses @ 99.9% confidence Level (s)
Economic Capital
Reserves
Value-at-Risk
VAR
Before we can develop adequate credit stress testing we need to understand the differences between traditional credit loss measures and what stress tests incorporate.
Aside form standard concentration and coverage analysis, a standard portfolio credit risk analysis typically employs a Value-at-Risk view.
Credit risk in this view generally follows a positive skewed distribution (by definition one cannot have negative defaults and thus a normal distribution is not applicable).
Reserves ALLL generally cover average expected losses over a horizon. In reality these are usually allocated to general reserves since most ALLL have two components: general reserves and specific reserves for known credits that are detraining.
Economic capital functions as a cushion against unexpected loss up to some confidence level. In this case 99.9% or a single “A” rating is the regulatory standard (once every 10,000 years)
In addition to a loss cushion economic capital represents the amount of the firm’s equity that is at risk which requires a return sufficient to cover the associated risk.
The shape of the curve or tail will then reflect the underlying credit risk of the portfolio or product.
However this view has some assumptions that can miss important risk elements.
The distribution is generally based on one variable PD in this case and does necessarily fully account for other correlated factors that when combined either change the tail or increase the likelihood of default.
Second, while the event may be rare, this methodology does not tell how severe or the magnitude of the event when it occurs beyond the confidence level prescribed for economic capital.
4
Old Measure: New Ones
RAROC - Risk Adjusted Return on Capital
EVA - Economic Value Added.
Hurdle Rate – What is it. How is it measured?
5
Time Line of the Early History of Commercial Banking in the United States
6
Historical Development of the Banking System
Bank of North America chartered in 1782
Controversy over the chartering of banks.
National Bank Act of 1863 creates a new banking system of federally chartered banks
Office of the Comptroller of the Currency
Dual banking system
Federal Reserve System is created in 1913.
7
Asymmetric Information and Financial.
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Mercer Capital's Bank Watch | July 2015 | Small Bank Holding Companies Regula...Mercer Capital
Brought to you by the Financial Institutions Team of Mercer Capital, this monthly newsletter is focused on bank activity in five U.S. regions. Bank Watch highlights various banking metrics, including public market indicators, M&A market indicators, and key indices of the top financial institutions, providing insight into financial institution valuation issues.
Credit Audit's Use of Data Analytics in Examining Consumer Loan PortfoliosJacob Kosoff
Written by Jacob Kosoff and published in September 2013 by the RMA Journal. This article describes banks in 2012 & 2013 were modernizing their Credit Review functions.
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Similar to Concentrations of Credit Presentation (20)
2. Introduction
• Credit extension is a primary source of revenue for Banks which risks earnings and
capital
• At the Heart is the “accurate identification of a borrower’s credit risk, the
assignment of a risk rating, and setting an adequate provision for loan loss”
• Illustration of FSG Bank risk rating scale mapped to that of rating agencies S&P
and Moody’s:
FSG AQR S&P Moody’s OCC/FDIC/FED
10 AAA Aaa
Pass
20 AA+
AA
AA-
A+
A
A-
Aa1
Aa2
Aa3
A1
A2
A3
30 BBB+ Baa1
60 CCC+ Caa1 Junk
3. Introduction_Cont’d
• However, Credit assessment also encompasses the management of
concentrations/pools of exposure, whose collective performance could
affect a Bank negatively.
• When therefore exposures in a pool are sensitive to the same economic,
financial, or business development, that sensitivity, once triggered could
cause all transactions to perform as though a single large exposure
• The Roles of the Bank with respect to Credit Concentrations then becomes
to:
a) Identify
b) Monitor
c) Measure
d) Control this risk related to Concentrations
4. What is key/Historic overview
• Understanding how the different exposures would work under stressed economic
situations is very key.
• In most instances in times past, concentrated exposures were booked during periods
of rapid economic expansion that were fueled partly by Bank Credit, frequently
including a weakening of underwriting Standards
• Below is a brief discussion of the 2009 Global Financial Crisis: a situation that
many believe would have been mitigated (in part) by Bank’s closely monitoring
various Credit profiles especially with respect to Real Estate Lending
5. 2009 Global Financial Crisis
• “Caused by Wide Spread failures in financial regulation and supervision…”
• The “Housing Bubble”_ Real Estate Markets typically involve longer boom
and bust periods. They are typically seen as an example of Speculative or
Credit Bubbles.
• Commercial Banks play a substantial role in Real Estate lending by advancing
Mortgages. These typically are easier to foreclose on owing to the availability
of tangible Collateral. However, in the event of a Crush like that of ‘09,
financial Institutions suffer a severe hit.
• The ‘09 Crisis, however, was controlled in large part by different Central Banks
advancing stimulus packages. This is a notion that aligns itself largely to the
Keynesian Economic school of thought that is briefly discussed below.
7. What then?
• In order to avoid situations like these, governing bodies like the OCC have
expectations that Bank Boards implement Board approved policies appropriate to
the size and complexity of their portfolios coupled with risk management, loan
review, and audit oversight.
• This typically involves a long process, and a constant updating of various loan
portfolios in a bid to mitigate risk outcomes.
• In order to asses Credit risk therefore, assets can typically be categorized into
different pools in accordance with similar performance traits.
8. Examples of Pool classifications
Historically, the OCC has categorized pools of transactions that may perform similarly
(i.e., whose performance is positively correlated) as those that include credit exposures
that are:
• dependent on the same source of repayment (including guarantors).
• extended to independent borrowers who sell the same manufacturer’s product.
• extended to an industry or to economic sectors.
• purchased from a single-source.
• secured by a common debt or equity instrument.
• extended to other financial institutions including but not limited to due from
accounts, federal funds sold, investments, net current exposure of derivatives
contracts, and direct or indirect loans.
• originated within a geographic area that might also be dominated by one or a few
business enterprises.
• owed by a foreign government or related entities.
9. Illustration _ finding similarities
• Assuming you had the following exposures grouped into different pools. Even upon grouping them, it
would be very likely that you would have similarities arise within the pools. This could call for an even
further assessment/grouping as shown below:
• NB: Our exposures are 1, 2, 3, 4, 5, 6, 7, 8, 9
Pool A
Includes exposures 2,5,8
Pool B
Includes exposures 4,3
Pool C
Includes exposures 6,9
Pool D
Includes exposures 1,7
Pool E
Could Include exposures
in Pools C and D if
similarities established
10. Plug In: Aggregating Credit
• In the event that a common enterprise exists, loans from different borrowers can
typically be aggregated. This principle is fairly similar to the above discussed issue
of pool classifications (asset groupings). However, this is dependent on various
prior stipulated conditions. For FSG Bank, these include:
a) The “expected source of repayment” for two or more loans is the same
b) Funds are borrowed for the purpose of acquiring ≥ 50% of voting securities in an
acquisition to a related borrower
c) The borrowers are related through common control and are financially
interdependent or engaged in interdependent businesses
11. “Common Control”
This is presumed to exist when:
• One or more persons acting in concert directly or indirectly have the power to vote
20% of any class of voting securities, or
• One or more persons acting in concert control in any manner, the election of a
majority of the directors, trustees, or persons exercising similar functions, or
• Any other circumstances exist which indicate that one or more persons acting in
concert exercise a controlling influence over management or policies of the entity
(for example, a general partner).
12. “Financial Interdependence”
Financial Interdependence is said to exist when:
• Fifty percent or more of one borrower’s annual gross receipts or gross expenditures
are derived from or paid to one or more related persons through common control.
Gross receipts and expenditures are defined to include loans, dividends, capital
contributions and similar receipts or payments.
13. Other considerations
Loans are also to be aggregated under the circumstances described below even though
there is no common enterprise:
• Loans are always to be combined when loans to a second borrower are made for
the “tangible economic benefit” of a first borrower, whether or not a legal exposure
is provided in the loan documents.
• Loans to partnerships, joint ventures, and associations are always to be combined
with loans to members, except for limited partners or members whose partnership
or membership agreements provide that they are not to be held liable for the debt or
actions of the partnership, joint venture, or association.
• Loans are to be combined when funds are borrowed for the purpose of acquiring
any interest in a partnership, joint venture, or association, without regard to the
percentage interest to be owned after the acquisition.
14. House and Portfolio limits
Concentrations or aggregations of risk significantly increase the potential for volatility
in portfolio credit quality and earnings. In that respect, the Bank’s Board has
established the following limits:
House Limits AQR Limits
Exceptions to
House Limits
require approval at
the next highest
required level
(not to exceed
CLC)
10,20 $7.5MM
30 $6.0MM
40 $4.0MM
50 $2.0MM
60 $1.0MM
Aggregation of 10 largest borrowers: 100% of Tier 1 Capital
15. Limits _ cont’d
Aggregate relationships representing exceptions to the
House Limits above shall not exceed:
100% of Tier 1 Capital
Relationships with multiple entities having different AQR’s shall be subject to general
interpolation to determine the appropriate House Limit based on weighted AQR.
Industry, property type: 50-75% of Tier 1 Capital
16. Excluded from House Limits
• Obligations of, or obligations guaranteed by, the GOOD FAITH and CREDIT of the
United States of America, or any public body or municipal entity or any political
subdivision with taxing powers and representing general obligations rated “A” or
better thereof;
• Obligations which the Bank would be authorized to acquire without limit as
investment securities;
• Guarantees or commitments or agreements to take over or purchase made by any
department, bureau, board, commission or establishment of the United States of
America or any corporation owned directly or indirectly by the United States of
America; or
• Any obligation fully secured by either:
Pledged cash on deposit with FSG, or
Readily marketable securities within the possession or control of FSG and subject
to prudent margin maintenance requirements
18. A Brief Discussion
• Stress Test can be defined as an “analysis conducted under unfavorable economic
scenarios which is designed to determine whether a Bank has enough Capital to
withstand the Impact of Adverse Developments.”_ Investopedia
• Key Issues focused on can include:
a) Credit Risk: The risk of loss of principal or loss of a financial reward stemming
from a borrower's failure to repay a loan or otherwise meet a contractual obligation
b) Market Risk: The possibility for an investor to experience losses due to factors that
affect the overall performance of the financial markets, and
c) Liquidity risk: The risk stemming from the lack of marketability of an investment
that cannot be bought or sold quickly enough to prevent or minimize a loss
19. Conclusion: MIS is valuable
• With respect to Mitigation of risk therefore, it is imperative that financial
institutions have Management Information Systems that they can greatly monitor in
a bid to safe guard themselves while providing quality services.
• Data quality is vital BUT so is the scope of data elements that are captured; these
should be proportional to the portfolio’s diversity and risk profile.
20. Sources cited:
• Comptroller’s Handbook Booklets
• OCC Issuances
• FSG Bank Loan Policy
• Investopedia
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Editor's Notes
For the above, exposures are different loans. The illustration is to show that different loans can be grouped into different pools but categorized with similar loans. However, Pool E shows that even beyond that grouping, you can have similarities arise within already grouped loans i.e different pools. This can call for a regrouping. I think that is what I was trying to capture here.