28. Managing credit risk Flashcards
Outline the credit risk management process
- Policy and infrastructure
- Credit granting
- Exposure monitoring, management and reporting
- Portfolio management
- Credit review
What is the purpose of policy and infrastructure?
- Ensures credit policies + procedures are documented to ensure effective identification, measurement, monitoring, control and reporting.
What are the 5 elements of policy infrastructure
- Establish appropriate credit environment
- Adopt credit risk policies and procedures
- Appropriate to business context
- Addressing range of topics
- Adopted by senior management
- Implement credit risk policies and procedures
- Communicate to all relevant employees
- Review at least annually ro reflect changes
- Develop methodologies and models, with appropriate systems
- Define data standards and conventions
What is credit granting?
- Extending credit to customers and other counterparties, esp
o Credit analysis/rating
o Credit approval
o Pricing and setting t+cs for credit
o Documentataion
What are the characteristics of an efficient credit rating process
- Needs to balance effectiveness and efficiency
- Based on pure judgement or deterministic modelling
- Must respond to changes in circumstances of counterparties – reviews etc
- Must reflect factors incl.:
o Repayment history
o Analysis of ability to pay
o Reputation
o Availability of guarantees or collateral
What will monitoring, managing and reporting on credit risk achieve?
- Prevent undue exposure to one counterparty
- Ensure appropriate portfolio diversification (eg by industry, location) and
- Provide early warning of possible adverse credit events (eg monitoring credit spreads and stock price volatility)
What is credit exposure
- Current – amount at risk today if all credit transactions were settled and credit assets sold
- Potential – amount that may be at risk in future- likely to be function of time to maturity and volatility of underlying
What are the uses of exposure limits?
- Pay attention to concentration risk and set limits for groups etc
- Uses of exposure limits
o Risk control – limits engagement in overly risky business activities
o Allocating risk-bearing capacity – limits must reflect mgmt’s assmt of risk/return trade-offs
o Delegating authority – ensures credit decisions are made by those with appropriate skill and delegated authority
o Regulatory compliance – regulators maintain close scrutiny of credit risk controls
Outline the best practices in credit risk reporting
Must be:
* Relevant and timely
* Reliable
* Comparable
* Material
Must include:
* Trends
* Risk-adjusted profitability
* Large individual exposures
* Aggregate exposures
* Exceptions to standard policies, limits etc
How can portfolio management be used to manage credit risk
Portfolio management function aims to optimise desired risk/return trade-offs by defining a target portfolio.
Credit policy will document strategies and financial vehicles that can be used, including:
* Buying / selling assets
* Securitising assets
* Hedging risk using derivatives
* Transferring risks
Outline how a credit review is carried out
- Separate group must:
* Review sample of transactions and associated documentation to ensure data is correct
* Test that systems are working
* Enforce uw standards
* Check policies and procedures are being followed - Must communicate to mgmt.
List credit risk management techniques
- Underwriting
- Due diligence
- Credit insurance
- Credit derivatives
- Credit Default Swaps
- Total Rate of Return Swaps
- Securitisation
- Credit-linked note
Explain securitisation
- Involves the pooling together with group of assets, combined with issue with one or more tranches of asset-backed securities.
- Cashflows generated by pool of assets are used to service interest and capital payments on asset-backed securities
What is a credit-linked note
- Collateralised vehicle consisting of bond with an embedded credit default swap
What is a TRORS
- Hedge price and default risk
- Total return from one asset or group of assets is swapped for return on another.
- If can’t short a security, might be able to hedge long position by paying TROR in a TRORS
