Required readings Flashcards
4 basic R types
Market
Credit
Liquidity
Operational
Counterparty R def + examples
Loss if a party of a contract failed to perform under the agreement terms (e.g. fail to provide promised goods, services, etc.)
Retail banking def + ex
Services for individual people, + daily financial needs. Personal bank accounts, credit cards, mortgages, ATMs, car loans
4 Types of borrowers
Retail B
Corporate B
Public B (e.g. local govnmts, airports)
Sovereign B (national govnmts)
5 Cs of credit
Character (borrower’s credentials and references)
Capital (corporation’s equity/debt relation)
Conditions (of the industry and country where company operates)
Capacity (company’s ability to meet obligations based on current & expected revenue and cashflow)
Collateral
Equity f
Equity = Assets - Liabilities
Investment grade ratings are
BBB / Baa or higher
What do Credit Rating Agencies go?
Provide assessments of the borrower’s creditworthiness
3 leading rating agencies
Moody’s
Fitch
Standard & Poor’s
What do Early Warning Signals do?
Alert lender of increased credit R
Expected Loss formula
EL = (1-PD)* 0 + PD * EAD * LGD =
PD * EAD * LGD // cause loss is 0 if does not default
EL = PD * EAD * (1 - RR)
10 day 95% VaR is 1mln, what does it mean
For example, the 10-day 95% VaR of a USD 1 million loan is the most you
would expect to lose in 10 days 95% of the time and depends on the volatility of the expected losses. The chance of exceeding this loss in this horizon is 5%
Contagion risk VS default correlation risk
If default of one borrower has negative effects on other borrowers (e.g. default of major customer or major supplier)
Def corr risk - where default of one borrower affects default of another borrower (e.g. when 2 companies are creditors to each other)
Whole loan sale
Method of credit RM. Selling loan to another institution
Syndication
Method of Credit RM - reduce exposure by sharing portion of a loan with other fin. inst. + share returns as well
Securitization
Method of Credit RM. Joining similar assets (mortgages) into pools and selling them to other fin inst or to capital markets. It releases liquidity for the bank to be able to make new loans.
Credit Default Swap
Method of RM, transfer credit R. Buyer makes periodic payments to seller of credit protection. In the adverse event, seller has to pay the contracted amount to the buyer.
Stressed VaR def
Replicating VaR calculation if the relevant market factors experience a period of stress
Stress testing def
Analysis of outcoma of a specific change of the parameter of a risk model (e.g. change in IR), or other material parameters
Scenario analysis
Evaluate portfolio performance in severe state of the world, hypothetical or historical
what is defined by hedge ratio
quantity of futures contracts to sell for each unit of the asset whose value change the firm is offsetting
Market liquidity risk
R that a position cannot be unwound (meaning - closed out) at the desired time, desired amount, without large transaction costs. Happens when turnover is low and few people are trading the asset
funding liquidity risk
loss bc of inability to meet it’s business obligations (e.g. depositor withdrawal demands, payroll, debt obligations)
2 measures for liquidity R management, confirmed by BCBS
LCR - Liquidity Coverage Ratio
LCR = (High-Quality Liquid Assets) / (Net Cash Outflows over 30 days) ≥ 100%
NSFR - Net Stable Funding Ratio
5 categories of operational risk
Internal process R - failed prescribed internal procedures and policies
People R - e.g. high staff turnover, inadequate staff training
Systems R - computer hardware and software
External R - natural disasters, climate, wars, terrorism, etc.
Legal R -
3 types of operational R
Inherent R - R existing if no control or mitigation is taken
Residual R - R remaining after a control is implemented
Secondary R - R that is a direct result of implementing the control
5 steps of dealing with operational R
Identify
Assess
Measure
Mitigate / control
Monitor + report.
Example of transition climate risks
R from policy changes, reputational impacts, technological innovations, change in market preferences
