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Credit risk management

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Credit risk management

  1. 1. CREDIT RISK MANAGEMENT THE COMMODITISATION OF CREDIT RISK TRENDS 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 MANAGEMENT PRODUCT/ KNOWLEDGE MANAGEMENT RISK MANAGEMENT TECHNOLOGY MANAGEMENT RISK ORIGINATION/ DISTRIBUTION PRODUCT MANUFACTURE PROCESSING/ ADMINISTRATION PRODUCT 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 MID-MARKET WHOLESALE SMALL LOW HIGH 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 •RISK SYNDICATION CREDIT RISK MANAGEMENT CREDIT REQUEST TRANSACTION CREDIT FUNCTION ORIGINATION CREDIT LIMIT •CREDIT ASSESSMENT •TRANSACTION ORIGINATION •MONITORING CREDIT LIMIT & CREDIT ADMINISTRATION •PREPARATION OF CREDIT REQUEST •PRICING/ STRUCTURING •ADMINISTRATION CLIENT
  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 ORIGINATION •STRUCTURING/ PRICING •ADMINISTRATION TRANSACTION ORIGINATION CREDIT REQUEST CLIENT CREDIT LIMIT & CREDIT CHARGE CREDIT FUNCTION •CREDIT ASSESSMENT •CREDIT PORTFOLIO ANALYSIS •SYNDICATION/ ASSET SALES CREDIT PORTFOLIO •CREDIT CAPITAL MANAGEMENT CREDIT CAPITAL CREDIT TRADING CREDIT PORTFOLIO MANAGEMENT & POSITIONING CAPITAL MARKET •SECURITISATION •CREDIT DERIVATIVES
  21. 21. CREDIT RISK ASSUMED & MANAGED CREDIT CAPITAL TRANSACTION CREDIT RISK INTERNAL CREDIT DEFAULT SWAP CREDIT RISK TRANSACTION CREDIT PORTFOLIO ORIGINATOR 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. CREDIT RISK MANAGEMENT ARCHITECTURE CREDIT ANALYSIS CREDIT PORTFOLIO MODELLING/ CREDIT PRICING CREDIT TRADING CREDIT CAPITAL MANAGEMENT ECONOMIC CAPITAL REGULATORY CAPITAL CREDIT ENHANCEMENT CREDIT ADMINISTRATION CREDIT SYSTEMS/ IT INFRASTRUCTURE
  27. 27. •CREDIT EXPOSURE - STATIC & DYNAMIC (PFCE MODEL) •DEFAULT PROBABILITY/ RATINGS MIGRATION •RECOVERY RATES •DEFAULT CORRELATIONS RATING MODELS •INTERNAL •EXTERNAL CREDIT ANALYSIS RISK DATA CREDIT MODELS •PORTFOLIO MODELS •PRICING MODELS TRANSACTION DATA OBLIGOR/ COUNTERPARTY DATA •ECONOMIC CAPITAL •REGULATORY CAPITAL CREDIT CAPITAL MANAGEMENT CREDIT DATA •COLLATERAL CREDIT ENHANCEMENT LIMIT ADMINISTRATION •PROVISIONING REPORTING •SETTLEMENT LIMITS •RISK LIMITS •NETTING •CLEARING HOUSE
  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 BORROWER DEPOSIT TRANSACTION BANK BANK ORIGINATES, FUNDS, ADMINISTERS AND RETAINS CREDIT RISK OF BORROWER DEPOSITOR
  32. 32. MODEL 2 - INVESTMENT BANKING/ SECURITIES MODEL ISSUE OF SECURITIES DISTRIBUTION OF SECURITIES BORROWER 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, INVESTOR
  33. 33. MODEL 3 - SECURITISATION MODEL SALE OF LOAN BACKED SECURITIES LOAN TRANSACTION BORROWER BANK SECURITISATION VEHICLE INVESTOR 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 BORROWER CREDIT DEFAULT SWAP OR CREDIT LINKED NOTE 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. INVESTOR/ OTHER BANK
  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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