market riskpractice question

7/25/2019 Market RiskPractice Question

1/99

TitleTitle

DateDate

Lifetime Learning Building Success TowardsGlobalization

CREDIT RISK MANAGEMENT

Lifetime Learning Building Success TowardsGlobalization


2/99

01/30/16

2

DECISION !"ING

Decision making process in general canbe of three types: When the outcome of a particular decision can

be ascertained with certainty

When the outcome of the decision cannot beascertained with certainty

Decision making is called a risky situation whenthe occurrence of an outcome can be assigned

some probability


3/99

Calculation of Z- Score

Total Current Assets - ! Total "i#ed Assets $ %& Total 'iabilities $ &( mn Current Assets$ &mn

Current 'iabilities $ %mn )etained *arnings $ &mn +perating ,ncome $ mn

Sales $ (..mn Current share price $! A*D /umber of shares $ (. mn shares


4/99

Capital required for a bank to sanctioncredit limits

#!CILIT$ !O%NT

&or'ing Ca(ital Loan 0.

Term Loan 1.

Letter of Credit )LC* !.

Ban' Guarantee (.

Deri+ati+es %

Total #acilities (.%mn

External Rating of the company is BBB.


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01/30/16

5

Risk, in traditional terms, is viewed as a 'negative'."exposing to danger or hazardexposing to danger or hazard".

The Chinese symols for risk give a m!ch etter description of risk The first symol is the symol for #dangerdanger$, while the second is the

symol for #opportunityopportunity$, making risk a mix of danger and opport!nity.

Risk leads to the prospects of either loss, or gain. The perception of risk is as old as h!man civili%ation.

Risk may e a so!rce of ha%ards and perils and also anopport!nity to achieve s!ccess and prosperity.

Without risk, there is no opportunityWithout risk, there is no opportunity.

&,at is -is'.
http://www.stern.nyu.edu/~adamodar/pdfiles/valrisk/ch1.pdfhttp://www.stern.nyu.edu/~adamodar/pdfiles/valrisk/ch1.pdfhttp://www.stern.nyu.edu/~adamodar/pdfiles/valrisk/ch1.pdfhttp://www.stern.nyu.edu/~adamodar/pdfiles/valrisk/ch1.pdf


6/99

&/$ T!"E -IS" .


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8/99


9/99

&/!T /!00ENS I# B!N"ST!"E TOO %C/ -IS" .


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11/99

! B-EI# /ISTO-$ !BO%T -IS"SIN B!N"S


12/99

B!N"ING TILL G-E!T DE0-ESSION O#1232

,n the (th Century2 3anks became powerfulentities supported by the wa4e of industriali5ationand de4elopment of large corporations6

The markets for securities and debt instrumentse4ol4ed signi7cantly during this period2 whichmade 3anks e8ually powerful6

This attack continued to gain signi7cance till thelate (!.s which saw the famous crash of the

stock market bubble and the subse8uent 9reatDepression6


13/99

Stoc' ar'et Cras, 4 GreatDe(ression

The stock markets crashed by nearly %. in (!6

The economic downturn that followed transformedinto a full scale recession across the globe2 wherenearly !% of workforce turn unemployed and

industrial producti4ity and national income hal4ed6 ;any 3anks also collapsed during the crisis6

The crash of the markets and the recession waslargely attributed to the e#cessi4e le4el ofspeculation2 low le4el of regulation by the

9o4ernment of the 3anks2 power in the hands of3anks and corporates and so on6

,t is in this conte#t2 that the famous 9lass-SteagallAct was framed6


14/99

GL!SS5STE!G!LL !CT

This Act formed the cornerstone of the 3ankingindustry in the !.thCentury6

This Act is also known as Banking Act of 19336

The Act created the barriers between Commercial3anking < Securities market industry6

This was enacted as at that time many blamedthe securities acti4ities of the 3anks as a ma=orreason for their collapse6


15/99

I0!CT O# GL!SS5STE!G!LL!CT

The Act changed the landscape of ,n4estment3anking industry for the ne#t && years6

The ma=or commercial 3anks closed down theirsecurities business6

This Act also led to the establishment of newSecurities 7rms6

The pro7tability of the 3anks were se4erely impactedas their most pro7table business was closed

;any of the pro4isions were 4ery harsh and led to asituation where the growth of 3anking industry wassigni7cantly a>ected in the ne#t two decades6


16/99

&atering Down of Glass Steagall!ct

The Act was a>ecting the growth of the 3ankingindustry6

;any subse8uent legislations watered down the 9-SAct6

Signi7cant among them was the decision toderegulate the interest rates2 permission gi4en formergers between commercial and securities 7rms in(?.@s2 permission gi4en to the 3anks to create new

instruments like the mortgage based securities etc6 The 3anking industry in *urope didn@t face such

se4ere restrictions like S6 This led to signi7cantgrowth in *uropean 3anking industry6


17/99

#inall6 t,e !ct is Gone77

,n (2 the passage of 9ramm-'each-3liley Actby 3ill Clinton 9o4ernment remo4ed all the ma=orbarriers in the industry which was there for &&years6

This Act formally dismantled the legal barriers forthe integration of 7nancial ser4ices 7rms andcommercial banks6


18/99

&,at ,a((ened ne8t7 .

Commercial banks are not supposed to be high-risk 4enturesB they are supposed to manageother people@s money 4ery conser4ati4ely6,n4estment banks2 on the other hand2 ha4e

traditionally managed money of people who cantake bigger risks in order to get bigger returns6

When repeal of 9lass-Steagall broughtin4estment and commercial banks together2 thein4estment-bank culture came out on top6 Therewas a demand for the kind of high returns thatcould be obtained only through high le4erageand big risk-taking6


19/99

Subse9uentl6 t,e crisis of3::;

Commercial banks traded in increasingly risky andcomple# securities2 continuing to buy and sell

mortgages2 collaterali5ed debt obligations and otherderi4ati4es6

3ecause of the instruments@ comple#ity and institutions@4ulnerable positions2 many banks faced stark lossesduring the !..? 7nancial crisis6

The crisis unfolded by the collapse of the ,n4estment3ank called 'ehman 3rothers@2 which was the

largest e4er bankruptcy in S6 ;any ,n4estment 3anks and Commercial 3anks

collapsed during the period and some sur4i4ed because

of the large go4t bailout during the crisis6


20/99

-IS"S #!CED B$ B!N"S


21/99

RISK MANAGEMENT


22/99

!N O


23/99

)isk

The word risk is deri4ed from an ,talianword )isicare which means To Dare6 ,nthis sense risk is a choice rather than fate6

)isk is uncertainty that an asset will earn ane#pected rate of return2 or that a loss mayoccur6

)isk is 4olatility2 where une#pectedchangesB positi4e or negati4e are 4iewedsymmetrically6

The ob=ecti4e of risk management is not theelimination of risk but to optimi5e it6


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24

-IS"S #!CED B$ B!N"S

C)*D,T ),S ;A)*T ),S ',E,D,TF ),S +G*)AT,+/A' ),S '*9A' ),S T*CH/+'+9,CA' ),S )*GTAT,+/ ),S +"" 3A'A/C* SH**T ),S C))*/CF ),S

D*),IAT,I*S ),S C+/T)F ),SS "+)C* ;AJ)* ),S )*9'AT+)F ),S


25/99

;arket risk

;arket risk is caused due to changes in themarket 4ariables ha4ing ad4erse impact onearnings of a bank or on its capital6

Those 4ariables are: interest rate2 foreigne#change2 e8uity price2 commodity price2 andli8uidity6


26/99

,nterest rate risk

Deregulation of interest rates has caused keencompetition and e#posed banks to greater interestrate risk6

3anks net interest incomeB di>erence betweeninterest recei4ed on its assets KloansLad4ances2in4estmentM and interest paid on its liabilitiesKdepositsM which is the ma=or source of pro7tabilityhas been shrinking6

;ismatch risk or gap riskB short term deposits ha4ebeen used to 7nance long term in4estments6

3asis riskB changes in interest rate a>ect assetsand liabilities di>erently6

Grice riskB 4alue of in4estments a>ected bychanges in interest rate6


27/99

'i8uidity risk

;ismatching in maturities of banks assets andliabilities cause banks to 7nance li8uidity atunfa4orable cost or forced to li8uidated assets atunfa4orable prices6

3anks with surplus li8uidity may also su>er dueto idling of funds6

ey ratiosB loan to deposit ratio2 li8uid assets tototal assets2 li8uid assets to total deposits2 inter-

bank-deposits to total deposits6


28/99

"oreign e#change risk

Ad4erse e#change rate mo4ements a>ect banksforeign e#posures when it is holding foreigne#change assets or liabilities6

Translation riskB arises from the need to translate

foreign currency assets and liabilities into homecurrency at end of accounting period6

*conomic riskB change in future earning powerand cash Now as a result of ad=ustment of thecurrencies6


29/99

Country risk

Cross border lending and in4estment2 whencounterparty is unable ser4ice and repay the debt6

Currency transfer riskB borrower is able to repay inlocal currency but there is shortage in foreign

currency6 Golitical riskB restrictions imposed

So4ereign riskB go4ernment in4ol4ed but inabilityto take legal action6

Cross border riskB borrower being resident of acountry other than where the cross border assetsare booked and e#posure to currencies other thanlocal currencies6


30/99

*8uity price risk

The risk that arises due to potential of abank to su>er losses on its e#posure tocapital markets from ad4erse mo4ements

in prices of e8uity6


31/99

Commodity price risk

Ghysical products that can be traded on asecondary market are more 4olatile and comple#6

3anks in de4eloped markets use deri4ati4es tohedge commodity price risk6


32/99

3usiness en4ironment risk

Arise when banks lending policiesLstrategiesparticularly relating to identi7cation of targetmarkets2 products and customer base2 withoutproper planning and study of the business

en4ironment6


33/99

+perational risk

Caused due to de7cient and fast changinginternal processLsystemsLproceduresB non-conduci4e work en4ironmentB de-moti4ateduntrained and incompetent sta> or from e#ternal

e4ents6 'egal risk

Technology risk

+utsourcing


34/99

9roup risk

Arises when a bank has otherdomesticLo4erseas subsidiaries dealing in4arious acti4ities such as merchant banks2

mutual funds2 insurance may not doingwell and incurring losses and in turn maye>ect their pro7tability6


35/99

Credit )isk "rame work


36/99

Credit risk

The possibility of losses associated with diminution in thecredit 8uality of borrowers or counter parties6

,n a banks credit portfolio2 losses stem from outrightdefault due to inability or unwillingness of a customer or

counter party to meet their commitments in relation tolending2 trading2 settlement and other 7nancialtransactions6

Alternati4ely2 losses result from reduction in portfolio 4aluearising from actual or percei4ed deterioration in credit

8uality6

Credit risk emanates from banks dealing with an indi4idual2corporate2 bank2 7nancial institution or a so4ereign6


37/99

"orms of credit risk

(6 ,n the case of direct lending: principal and Lor interest

amount may not be repaid6!6 ,n the case of guarantees or letter of credits: funds may

not be coming from the constituents uponcrystalli5ation of the liability6

06 ,n case of treasury operations: the payment or series ofpayment due from the counter parties under the

respecti4e contracts may not be forthcoming or ceases616 ,n case of security trading business: fundsLsecurities

settlement may not be e>ected6

%6 ,n case of cross-border e#posure: the a4ailability andfree transfer of foreign currency funds may either befro5en or restrictions by the action of2 or because ofpoliticalLeconomic conditions in the country whereborrower is located6


38/99

Credit )isk in /on-fund basedfacilities

3anks should ensure that the security2 which isa4ailable to the funded lines2 also co4ers the letter ofcredits lines and the guarantee facilities6 ,n case oflong term guarantee a charge o4er 7#ed assets will beappropriate6

,n case of guarantees co4ering contracts2 banks mustensure that the clients ha4e the re8uisite technicalskills and e#perience to e#ecute the contracts6 Ialue ofcontracts must be determined on a case by case basisand separate limits should be set up for each contract6

The strategy to sanction non-fund facilities with a 4iewto increase earnings should be properly balanced withthe risk in4ol4ed6


39/99

D,SCSS,+/

&/!T !-E T/E !=O- -E!SONS #O-C-EDIT -IS" .

#!CTO-S C!%SING C-EDIT -IS"


40/99

#!CTO-S C!%SING C-EDIT -IS"

(6 De7ciencies in appraisal of loan proposals and in

assessment of creditworthinessL 7nancial strength ofborrowers6!6 ,nade8uately de7ned lending policies and procedures6

06 High prudential e#posure limits for indi4idual and groupof borrowers6

16 Absence of credit concentration limits for 4ariousindustriesLbusiness segments6

%6 ,nade8uate 4alue of collaterals obtained by banks tosecure the loan facilities6

&6 +4er optimistic assessment of thrustLpotential areas ofcredit6

6 'iberal loan sanctioning powers for bank e#ecuti4eswithout checks and balances6

?6 'iberal sanctioning of non-fund based limits withoutproper scrutiny of borrowers acti4ity2 7nancial strength2cash Now6

"actors causing credit risk


41/99

"actors causing credit risk

(6 'ack of knowledge and skills of oOcials processing loan proposals andsub=ecti4ity in credit decisions6

!6 'ack of e>ecti4e monitoring and consistent approach towards earlyrecognition of problem accounts and initiation of timely remedial actions6

06 'ack of information on functioning of 4arious industries and performance ofeconomy6

16 'ack of proper coordination between 4arious departments of banks looking

into credit functions6%6 'ack of well de7ned organi5ational structure and clarity with regard to

responsibilities2 authorities and communication channels6&6 'ack of proper system of credit risk rating2 8uantifying and managing across

geographical and product lines66 'ack of e>ecti4eness of e#isting credit inspection and audit system in

banks6?6 'ack of reliability and integrity of data being used for managing credit risks66 Sta> accountability as result de-moti4ating the sta>6


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C-EDIT -IS" !N!GEENT

0-OCESS IN B!N"S


43/99

P i i l f C dit Ri k t i B k


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Principles of Credit Risk gmt! in Banks"per BA#$%&

3anks must operate within sound2 well-de7ned credit-

granting criteria6 These criteria should include a clear indication of the bank@s target

market and a thorough understanding of the borrower or counterparty2as well as the purpose and structure of the credit2 and its source ofrepayment6

3anks must recei4e suOcient information to enable a comprehensi4eassessment ofthe true risk pro7le of the borrower or counterparty6Depending on the type of credit e#posure and the nature of the creditrelationship to date2 the factors to be considered and documented inappro4ing credits include:

*stablishing an appropriate credit risk en4ironment

+perating under a sound credit granting process6 ;aintaining an appropriate credit administration2 risk

measurement and monitoring process6

*nsuring ade8uate controls o4er credit risks6

C-EDIT -IS" !N!GEENT


45/99

C-EDIT -IS" !N!GEENT0-OCESS

3S,/*SS ),S A/A'FS,S

",/A/C,A' ),S A/A'FS,S

S*C),TF < C+''AT*)A';A/A9*;*/T

),S ;+/,T+),/9 < ;A/A9*;*/T

BUSINESS RISK


46/99

C!SE ST%D$51

,D*/T,"F TH* *F ),SS W,TH TH*

C+;GA/F6

!-!BTEC

E!- 0-O0E-TIES

E!- !LLS

D%

N!"/EEL

BUSINESS RISK

IDENTI#$ING T/E


47/99

IDENTI#$ING T/E#IN!NCI!L -IS"

C!SE ST%D$53

,D*/T,"F TH* *F ),SS W,TH TH*

C+;GA/F6


48/99

#IN!NCI!L -IS" !N!L$SIS-!TIO 4 C!S/ #LO& !N!L$SIS

SOE "E$ #IN!NCI!L -!TIOS


49/99

SOE "E$ #IN!NCI!L -!TIOS

Debt > E9uit6

TN&

TOL?TN&

EBITD!

Net 0ro@t argin

Cas, !ccruals

DSC-

LEVERAGE RATIOS

PROFITABILITY RATIOS

CASH FLOW ADEQUACY


50/99

C!0IT!L ST-%CT%-E 5 LE EA%IT$ -!TIO


51/99

DEBT> EA%IT$ -!TIO

+ne of the most critical ratios in Gro=ect lending

This ratio indicates how many times the +wn funds@has the company borrowed money

0roectDebt? E9uit6

&/!T IS T/E !CCE0T!BLE LE


52/99

Tangible /et worth $

S,are ca(ital -etainedEarnings -eser+es5)IntangiblesM

-+ne has to careful on the )eser4es part6

-*#clude )eser4es like "i#ed Assets )e4aluation reser4e whichis =ust a notional item and not actual reser4es6

Tangible Net wort,

It is the most m!o" mes#"e o$ the %om&'()s $i''%i* st"e'+th, It

sho-s the %om&'()s .i*it( to meet the Li.i*ities.

TOL?TN&


53/99

This ratio is a critical measure of sol4ency of thecompany6

,t shows how many times your /etworth KownfundsM is the +utsider@s liabilities6

The ratio $Total +utsider@s 'iability

--------------------------------- /etworth

The benchmark ratio in this regard is a ma#imumof 0 times6

The benchmark can 4ary from 3ank to 3ankdepending on their risk appetite6

TOL?TN&

DSC)


54/99

DSC)

This is one of the most important ratio in Gro=ect"inance6

This basically tests w,et,er t,e internalfunding from t,e business is ade9uate to

meet t,e loan re(a6ment obligations to t,eBan'

Debt Ser4ice Co4erage ratio2 tests the ability of acompany to ser4ice the

0rinci(al re(a6ment

Interest ser+icing


55/99


56/99

!=O- 0-O#IT!BILIT$ 4O0E-!TING -!TIOS

Net 0ro@t -atio


57/99

This ratio calculates the pro7t margin of acompany on the /et sales6

,t is calculated as

$ Gro7t After Ta#

-----------------------

/et Sales

Gro7t before Ta# also is analy5ed as a percentageof /et sales6

Net 0ro@t -atio

Cas, !ccruals


58/99

Cas, !ccruals

This refers to the Cash pro7ts generated in thebusiness6

The /et ,ncome KGATM in the "inancial statementsis after ad=usting for non cash e#penses like

depreciation6

Due to this the )eported Gro7ts could di>er fromthe Cash Gro7ts6

Cas, !ccruals 0!T De(reciation

EBITD!


59/99

The ob=ecti4e of this ratio is to calculate theoperating pro7ts made by the company from thecore business operations6

The ratio calculates the operating pro7t margin

on the /et sales made6

*3,TDA

------------- P (..

/et sales

EBITD!)Earnings before Interest Ta8F De(reciation 4!mortization*

This is an indicator of the Core +perating Gerformance of thecompany.


60/99

Cs of C-EDIT -IS"

%CS


61/99

%CS

Character

Capacity

Capital

Collateral

Conditions


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C-EDIT -IS" -!TING

Credit risk rating ob=ecti4es


63/99


(6 Taking credit decision6

!6 Gricing of loans6

06 ;itigation of risk6 Customercontribution6

16 /ature of facilities6

%6 Delegation of sanction power6



64/99


(6 Selecti4e monitoring6

!6 *nsuring 8uality6

06 ;igration of credit6 Higher to lower

16 ;anagement of credit risk6

%6 ,denti7cation of safe and risky

areas6

!N O


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!N O


66/99

C-EDIT -IS" SCO-INGH5SCO-E ODEL

Z- score ;odel


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Z score ;odel

Some 7nancial ratios ha4ingsigni7cant discriminating power toseparate healthy and weak units6

Z$ 3(P(R3!P!66R 3nPn

3 $ 4arious discriminant coeOcient

P $ independent 4ariables


68/99

The H5score formula for (redicting ban'ru(tc6was published in (&? by *dward ,6 Altman6 Theformula may be used to (redict t,e (robabilit6 t,ata @rm will go into ban'ru(tc6within two years6

Z-scores are used to (redict cor(orate defaults andan easy-to-calculate control measure for the 7nancialdistress status of companies in academic studies6

The Z-score uses multiple corporate income andbalance s,eet +aluesto measure the 7nancialhealth of a company6

Z - score
http://en.wikipedia.org/wiki/Edward_I._Altmanhttp://en.wikipedia.org/wiki/Edward_I._Altman


69/99

Z score

Z= 1.2X1/1.4X2+ 3.3X3+ 0.6X4+ 0.999X5

H5 score model


70/99

H score model

(6 9reater than !6&% Healthy units with lowprobability of default

! 3etween (6?( and !6&% 9rey area with both

bankruptcy and nonbankruptcy possibilities6

0 'ess than (6?( "inancial Distress Highchances of default

KAltmanM Z-score


71/99

KAltmanM Z score

if KZU (6?(M the 7rm will default6 ,f Z K(6?(:!6&%M2

the 7rm will either default or not6 ,f KZV !6&%M2the 7rm will not default6

C!SE ST%D$53


72/99

C!SE ST%D$ 3

H5SCO-ING #-!E&O-"

GA)T-,,


73/99

GA)T ,,

B!SEL5II INSIG/TSON C-EDIT -IS" !N!GEENT


74/99

Basel Committee on Banking Sue!"ision#BCBS

$ %ommittee o& %ent!al 'anke!s( 'ank sue!"iso!s &!om ma)o!in*ust!ialie* %ount!ies like Belgium, Cana*a, -!an%e, e!man/,tal/, aan, uem'ou!g, te ete!lan*s, Sain, Se*en,Site!lan*, 7nite* 8ing*om an* 7nite* States.

BCBS as no &o!mal su!anational auto!it/ no! legal &o!%e

oe"e! :- , ;o!l* Bank, nte!national


75/99

Basel Accord I (1988)

o!t&olio $!oa% > t &o%use* !ima!il/ on %!e*it !isk an* assets o&

te 'anks e!e %atego!ie* into !isk 'u%kets it !isk eigts !anging&!om 0? to 150?.

:inimum Caital A? o& !isk eigte* assets onl/ &o!%!e*it !isk.

Base* on 19AA a%%o!*, %ent!al 'anks initiate* "a!ious a%tions &o! te'anks like %lassi&i%ation o& assets, !o"ision no!ms, %lassi&i%ation o&

asset %lass et%.

P"ti%#*"s Ris0 Wei+ht

Cas4 in 4an*, Balan%e 6it4 'anks, n"estment in

go"e!nment se%u!ities et%0?

:one/ at %all an* s4o!t noti%es, n"estment un*e!

go"e!nment gua!antee* se%u!ities, $*"an%es to

sta&& mem'e!s et%

20?

Claim gua!antee* '/ DCC(C 50?

$*"an%e to u'li% against 9ousing -inan%e 5?

$*"an%es to %o!o!ates, %laim on =S7s, S:

an*


76/99

D -< $ ; -


77/99

.$0 ACC'R+

Approaches to measure Credit

risk Standardi5ed approach

,nternal ratings based K,)3M approach

"oundation

Ad4anced Approaches to measure Operational risk

3asic ,ndicator Approach

The Standardised Approach

Ad4anced ;easurement Approach

Approaches to measure Market risk Standardised method

,nternal ;odel


78/99

Approachesto Credit Risk anagement underBasel,,

INC-E!SED

SO0/ISTIC!TION

-ED%CED C!0IT!L-EA%I-EENT

ST!ND!-DISED

!00-O!C/

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

assessment institutions

#O%ND!TION

INTE-N!L-!TING B!SED

!00-O!C/

Banks use internal estimations

of probability of default !"# tocalculate risk weights forexposure classes. $ther riskcomponents are standardi%ed.

&"'&()*"

+(,*R(&- R&,+(B&*"

&!!R$&)

Banks use internal

estimations of !"loss gi2en default-"# and exposure atdefault *&"# tocalculate risk weightsfor exposure classes

DISC%SSION


79/99

Why do all 3anks run behind top ratedcorporates to o>er them loans at low rates

Why is 4ery higher rate charged oncustomers with a4erage or weak 7nancials

Why )esidential ;ortgage is a preferred

business for all A* 3anks

&,6 all Cor(orate Customers are not t,e samef t, B ' .


80/99

for t,e Ban' .

The 3ank has to set apart some capital when it lends

money as per the 3AS*' /orms which is adopted by allthe 3anks of A*6

The amount of capital set apart can 4ary from customerto customer6

,t depends on some key factors like the e#ternal rating ofthe customer Kby appro4ed rating agencies like ;oody@sM

2 type of facilities etc6

,f customers with Higher )atings@ are selected2 it means

that the 3ank has to set apart lesscapital6 This in turn

leads to reduced risk and better pro7tability for the3ank6

,f Customers with poor ratingLno rating is selected2 it willlead to higher capital re8uirement6

Credit -is'


81/99

)isk Weights for some Asset


82/99

gclasses

+> 3alance Sheet Credit )isk


83/99


84/99

Credit Risk #tandardised

Approach )isk weights are assigned in slabs of .2 !.2 %.2(.. < (%. on the basis of rating assigned by*CA,s6 "or e#ample -- Claims on So4ereigns KorCentral 3ankM . to (%. risk weight on the basis

of country risk scores and at national discretion2 alower risk weight may be applied6

Claims on Corporates will be risk weighted in therange of !.-(%. and unrated Corporates will be

assigned (.. risk weight6

A* Central 3ank has speci7ed 13 Ca(ital c,arge

'2 Balance sheet items under #tandardisedapproach


85/99

pp

The credit risk e#posure attached to o>-3alance Sheet items has to be7rst calculated by multiplying the face 4alue of each of the o>-3alance

Sheet items by credit con4ersion factorKCC"M6 This will then ha4e to beagain multiplied by the risk weights attributable to the rele4ant counter-party as speci7ed in pre4ious slide6

/r.

(o.

+nstruments )redit

)on2ersion

3actor 4#

1 Direct credit substitutes e.g. general guarantees of

indebtedness (including standby !"s ser#ing as

financial guarantees for loans and securities$ and

acce%tances (including endorse&ents 'it te

caracter of acce%tance$.

100

2 "ertain transaction)related contingent ite&s (e.g.

%erfor&ance bonds* bid bonds* 'arranties and

standby !"s related to %articular transactions$.

50

+ ,ort)ter& self)li-uidating trade)related contingencies

(suc as docu&entary credits collateralised by te

underlying si%&ents$ for bot issuing ban and

confir&ing ban.

60

/// 0bo#e list is not eausti#e.

Credit )isk ;itigants under Standardi5edApproach


86/99

pp

*ligible collaterals

Cash or deposit with bank2 9old Securities issued by Central and State 9o4ernments

/ational Sa4ings

'ife insurance policies K up to surrender 4alueM

Debt securities rated by a recognised Credit )ating Agencyha4ing at least 33 rating when issued by public sectorentities and at least Arating when issued by other entities6

Debt securities not rated by a recognised Credit )atingAgency where these are issued by a bank2 listed on a

recognised e#change and classi7ed as senior debt *8uities included in main inde#6

;utual funds ha4ing publicly 8uoted daily prices6


87/99

CO-E O# B!SEL JII


88/99

C!LC%L!TION O# C!0IT!L C/!-GE

Credit #acilit6 !mount

CASH C)*D,T KWCM %.

T*); '+A/ 1.

'*TT*) +" C)*D,T 0.

3A/ 9A)A/T** 0.

"+)WA)D CTLD*),IAT,I*',;,T KC*'M

!.

Cash margin on 'C is at (.

Cash margin on 39 is at (.T,e com(an6 ,as an e8ternal rating of BBB b6ood6sC*%#*te the %&it* %h"+e $o" the B'0.

C!0IT!L C/!-GE


89/99

acility !roposed

-imits

*ffecti2e

*xposure

"# 7

))

4#

*#

Risk

8eight

4# #

BBB

Risk

8eighted

*xposure

9 "7*7#

)apital )harge

9 7 14#

1. 3" 5

2. 6)1 4

+ " (Docu&$ +

4 37 +

5 C*' 2

,otal

T


90/99

C!0IT!L C/!-GE #O- DI##E-ENTT$0ES O# EK0OS%-ES


91/99

&EIG/T

No T$0E O# !SSET -IS" &EIG/T( C+)G+)AT* *PG+S)*S 3ased on *#ternal rating KCo4ered

in earlier slideM

! Gublic Sector Companies,n 9CC if recogni5ed as

public sector by localregulator

. if in local currency6 "oreignCurrency loans X!.

0 *#posure on other 3anks "urnished in ne#t slide

1 *#posure on "inance Cosetc

"urnished in ne#t slide

% )etail KComply withConditionsM

%

& )esidential ;ortgage 0% K ,f 'TI less than ?% andloan amount is less than (.mnM

E8(osure on ot,er Ban's


92/99

E8(osure on ot,er #inanceCom(anies

,f regulated like 3anks2 the treatment as abo4e6 ,fnot treated like corporate6

)etail *#posures


93/99


94/99

-our /ey Risk $lements in ,RB Approach


95/99

0robabilit6 of Default)0D*

It measures the likelihood thatthe borrower will default over a

given time-horizon.

Loss Given Default

(LGD)

It measures the proportion of

the exposure that will be lost

if a default ours.

!xposure at Default

(!"D)

It measures the amount of thefailit# that is likel# to be drawn

if a default ours .

$aturit#

($)

It measures the remainingeonomi maturit# of the

exposure .

Probability of +efault "P+&


96/99

Probability of +efault "P+&

Grobability of default measures thelikelihood that theborrower will default o4er a gi4en time-hori5on i6e6What is the likelihood that the counterparty will

default on its obligation either o4er the life of theobligation or o4er some speci7ed hori5on2 such as anyear6

"or estimation of GD2 bank should already ha4e )isk

)ating System in place for the last % years and the

history ofdefault rates is being tracked since then6

%oss i4en +efault "%+&


97/99

%oss i4en +efault "%+&

Loss Gi+en Default is t,e credit lossincurred if anobligor of t,e ban' defaults7 LGD 1 :-eco+er6 -ate

w,ereF -eco+er6 0resent


98/99

$5posure at +efault

"$A+& EK0OS%-E !T TIE O# DE#!%LT )E!D* IS T/E TOT!L B!N"S ONE$ !T -IS"

aturity "&


99/99

aturity "& ,t measures the remaining economic maturity of the

e#posure6

Determines framework for comparing di>erent e#posures6

10000

01/01/003

31/1/006

;.004

1

3

,ime !eriod

in years

)ash

flow

!resent 'alue of

)ash low x c#

B# c#

1 ;00

market riskpractice question

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