Chapter 24 - Credit risk management

Question 1

Credit risk management process (detailed)

Answer 1

Policy infrastructure
Establish appropriate credit environment
Adopting and implementing credit risk policies and proc
Develop methods, models, appropriate systems
Define standard and conventions

Credit granting
Credit rating (reflect borrowers’ history, ability to pay, reputation, availability/enforceability of guarantees/collateral
Pricing and setting terms
Documentation

Exposure monitoring, management and reporting
Prevent undue exposure, ensure diversification
Manage through expsoure limits-risk control, allocation of risk-bearing capacity, delegation of authority, reg compliance
Reporting high trends and risk areas (exceptionis/exposures)

Portfolio management
Pursue target portfolio using fin vechicles

Credit review
Review sample transactions/documentation
Test systems, and that policies and proc are followed
Enforce underwriting standards
Highlight deficiencies and timeframes for resolution

Question 2

Credit risk management process (short-list)

Answer 2

Policy and infrastructure
Credit granting
Exposure monitoring, management and reporting
Portfolio management
Credit review

Question 3

Advantages of best practice in credit risk

Answer 3

Improvement of credit approval and prciing decisions at transaction level

Concentration of credit risk controlled at portfolio level

Smoother earnings due to better projections of losses

Improved management decision-making from advanced credit metrics and reporting

Risk return profile improved by active portfolio management and risk transfer strategies

Question 4

Credit risk management techniques

Answer 4

SID CUD

Underwriting

Due dilligence

Credit insurance

Credit derivatives

Securitisation

Credit-linked notes

Question 5

Credit default swaps (CDSs)

Answer 5

Provides payment if a credit event occurs:
Bankruptcy
Rating downgrade
Repudiation (debit issuer cancels outstanding pmts)
Failures to pay a coupon
Cross-default (credit event on another security)

Amount of payment is difference original price of reference asset (could be portfolio) and recovery value

Question 6

Total Rate of Return Swaps

Answer 6

Hedges price and deafult risk

Swaps the total return from one asset for return from another

Allows diversification