Ch2 - Governance

Question 1

Governance and CR

Answer 1

• Problems that lead to bankruptcy occur when portfolios of toxic transactions are built
• The best way to avoid losses is not to enter into bad transactions to start with
• Best practice for the governance system revolves around four key principles:
  1. Guidelines
  2. Skills
  3. Limits
  4. Oversight

Question 2

Guidelines

Answer 2

A set of documents that explain the rules that must be complied with before a transaction is concluded

• They should be understandable, concise, precise and accessible
• Created by the executive management team in conjunction with risk

Question 3

Setting Limits

Answer 3

• Represent the absolute dollar amount of risk that a company wants to take (or max losses prepared to withstand)
• Limits are often more an art than a science, and often experience and gut feelings will prevail

Question 4

Skills

Answer 4

• Originators typically want maximum freedom that risk managers do not want to give them; they have the responsibility to sell the products and grow the business
• Delegation of authority follows a two-step process:
  
  1. assignment of parameters (based on amount of exposure, credit quality and tenor)
  2. delegation of approval authority based on these parameters (riskier transaction required higher approval)

Question 5

Oversight

Answer 5

• Independence of risk management unit: separate location to profit, and remuneration shouldn’t be based on profit
• Qualifications: quality risk managers that are on the same page
• Proximity to business unit: as they need a full understanding of the underlying business
• Open mind: “a good risk manager does not say no, but how”

Question 6

Tutorial2: “Borrowers need not study credit risk analysis because it is the territory of the lending institutions”. Do you agree.

Answer 6

Customers need to understand how credit scoring works, what makes you use points, what is expected out of you to honour your financial commitments. A better understanding between banks and their customers would facilitate the whole process.

Question 7

Tutorial2: Is credit risk an art or a science?

Answer 7

The modern way of doing credit analysis is through credit scoring and has become more of a science than an art. However, credit analysts are required to develop skills to question the models they are developing and foresee any issues that may lead to inaccurate credit predictions. So good and sound credit risk analysis is a combination of both.