credit risk management _compatibility mode

8/8/2019 Credit Risk Management _compatibility Mode

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RISK

11/22/2010Risk Management-Credit 2


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What is Risk?

The variability or volatility of unexpectedoutcome

Why to Take Risk?

Risk creates value and profits come fromtaking Risks



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BANKS ARE IN BUSINESS OF TAKING RISKBut

Excessive risks BankruptcyAvoiding all risk Stagnancy

BASEL-II: MORE RISK MORE CAPITAL

SOLUTIONMANAGE RISK


(A structured approach for evaluating and managing the uncertainties)


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Credit Risk

Market Risk

oLiquidity

oInterest rateoForeign exchange

oCommodities and Equity

Operational Risk



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CREDIT RISK



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Inability or unwillingness of the borrower to eitherrepay amount due towards him/her or delayedrepayment of amount due towards him/her

In banking possibly the most important in terms

of potential losses

Exist throughout the activities of a bank1) Banking book

2) On and off the balance sheet

3) Trading book



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Credit risk can thus be said to constitutethree elements:

Default risk- missing a payment obligation orbreaking a covenant

Exposure risk- uncertainty associated withdue towards customer at time of default

Recovery risk- The unpredictabilityassociated with recoveries with the advent ofdefault



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CREDIT RISK MANAGEMENT



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Risk Management Guidelines by SBP Directives for implementing Basel-II Prudential Regulations for

oCorporate/CommercialoSMEoAgricultureoConsumer

SECP regulations Laws of the country International laws regarding settlement-UCP

600



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Need for maximizing shareholders value

Adopting policies/procedures which makeinstitution compliant with risk managementframework put forward by State Bank of

PakistanNeed to control rising NPLs of the Bank

Introduction of Basel-II has resulted in closeralignment of regulatory capital and economicrisks

Changes in global and local economicscenario can cause a counterparty to default



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TOOLS FOR CREDIT RISK

MANAGEMENT



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External limits set on the maximum loan sizeto an individual borrower or group

Uneven distribution of credit can generatinglosses large enough to jeopardize an

institutions solvency

Exposure limits will be set for the following:oIndustry ExposuresoBusiness Segments/ProductsoMaximum exposure under various risk classes

oCounterparties (i.e. individual/Group)



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Credit assessment of the borrowers industry,and macro economic factors.

The purpose of credit and source of repayment.

The track record / repayment history of

borrower. Assess/evaluate the repayment capacity of the

borrower.

The Proposed terms and conditions andcovenants.

Adequacy and enforceability of collaterals.

Approval from appropriate authority



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Set up comprehensive risk rating system

(Architecture of Rating Model discussed in laterpart)

Clearly define rating thresholds

Review the ratings periodically

Rating migration is to be mapped to estimate

the expected loss



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Expected (EL)

Priced into the product (risk-based pricing)

Unexpected (UL)

Covered by capitalreserves (economic capital)

Probability

Loss (L)


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Defining a Portfolio mix as per strategyguidelines provided by management

Standardize risk measures for maintainingasset quality

Manage concentrations Establish objectives for credit quality and

measure quality of asset portfolio in line theobjectives set thereon

Rebalance the portfolio to achieve strategic

objectives



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Pre-disbursement audit custodian Custodian of charge documents/securities

Maintenance of Credit file

Monitoring of adherence to the terms and

condition of approval Sending ticklers

Calculation drawing power will

periodic reassessment of the security value



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Negotiation and follow up- implement remedialplans

Workout remedial strategies- such as of loanfacility, enhancement in credit limits or reduction

in interest rates help improve obligors repaymentcapacity

Review of collateral and security document- Toascertain the loan recoverable amount andenforceability of contracts andcollateral/guarantee.

Status Report and Review- development of the loanaccounts and progress of the remedial plans



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CREDIT RISK MEASUREMENT



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How is Credit Risk measured?

By estimating the amount that can potentiallybe lost if a borrower defaults

Why to measure Credit Risk?

BaselBasel--IIII RequirementRequirement == CapitalCapital toto bebe allocateallocateagainstagainst creditcredit riskrisk takentaken



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INCREASEDSOPHISTICATION

REDUCED CAPITAL REQUIREMENT

STANDARDISED

APPROACH

Risk weights are assigned in slabsaccording to the asset class or are basedon assessment by external creditassessment institutions

FOUNDATIONINTERNAL RATING

BASED APPROACH

Banks use internal estimationsof probability of default (PD)to calculate risk weights forexposure classes. Other riskcomponents are standardized.

ADVANCEDINTERNAL RATING

BASED APPROACH

Banks use internalestimations of PD,loss given default(LGD) and exposure atdefault (EAD) tocalculate risk weightsfor exposure classes


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Obligor Risk

Industry Risk Business Risk Management Risk Financial Risk

IndustryCharacteristics

Industry Financials

Market Position

OperatingEfficiency

Track Record

Credibility

Payment Record

Others

Existing Fin. Position

Future FinancialPosition

Financial Flexibility

Accounting Quality

External factorsScored centrally once

in a yearInternal factorsScored for each borrowing entity by the concerned creditofficer

CREDIT RISK MEASUREMENT


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FRR


Loan Structure Term Structure

a. Nature andpurpose

b. Product typed. Priority of rights in

case of bankruptcy

e. Degree ofcollateralizationf. Composition of

collateral

a. Natureb. Qualityc. Liquidityd. Market valuee. f. Quality of the charge

g. Legal status of rightsh. Legal enforceabilityi. Time required to disposeoff


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QuantitativeEvaluation

QualitativeEvaluation

InternalObligorRating

Loss Given Default(LGD)

Exposure at Default

(EAD)

Correlation

Stress Testing

Calcul

ationofCredit

RiskAmount

ExpectedLoss(EL)

UnexpectedLoss(UL)

RiskComponents

Financial Data

PortfolioMonitoring

Provisioning

Pricing

Profit

Management

CapitalAllocation

Reporting tothe Board

Migration MatrixProbability of Default

(PD


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CREDIT RISK IN TRADING BOOKS



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Institutions exposures in financial instrumentsand commodities

Held with the intention of trading

Held for hedging one or more of the other

exposuresfree of any restrictive covenants on tradability

Can be completely hedged

Frequently and accurately valued



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Default Risk:The possibility that a issuer of an financialinstrument will fail to repay principal andinterest in a timely manner.

Settlement Risk:

The risk that one party will fail to deliver theterms of a contract with another party at thetime of settlement

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credit risk management _compatibility mode

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