Week 7: Credit Risk (Part 2)

Question 1

What is loan migration analysis?

Answer 1

• A loan migration (or transition) matrix seeks to reflect the historic experience of a pool of loans in terms of their credit-rating migration over time

Question 2

What does the concentration limit model do?

Answer 2

• External limits set on the maximum loan size to
individual borrowers.
• Concentration limit (i.e. maximum loans to a single sector as a percent of capital) = maximum loss as
a percentage of capital / loss rate.
• Used to reduce exposures to certain industries
and to increase exposure to others.

Question 3

What is Modern Portfolio Theory (MPT)?

Answer 3

• MPT can be used to measure and control an FI’s aggregate credit risk exposure through diversification.

Question 4

What is a fundamental lesson of MPT?

Answer 4

• Fundamental lesson of MPT: By taking advantage
of its size, an FI can diversify large amounts of credit risk, if there is imperfect correlation of the
returns of different assets.

Question 5

facts about moodys Analytics

Answer 5

• Moody’s Analytics: Preferred stock and junior subordinated bonds has the
highest LGD, while the senior secured bonds/loans has the lowest LGD.
• Basel Committee: 45% LGD on loans if secured by physical (non
‐real estate)
collateral, 40% if secured by receivables.
• Commonly 20% LGD (i.e. 80% recovery rate) on bank loans

Question 6

What does the loan volume-based model do?

Answer 6

• Data provides market benchmarks against which
FIs can compare their loan portfolios.

• Data can be gathered from the report to the
central bank and/or data on shared national credit
database.

• Deviations from the market portfolio benchmark
indicate the relative degree of loan concentration.

Question 7

What does the loan loss ratio-based model do?

Answer 7

• Estimates systematic loan loss risk of a particular
sector or industry relative to the total loan portfolio.

• Use of time-series regression of
ith sector’s loss
rate on the loss rate of the total loans: