Credit Risk Management in Banks

Presented By: 

Patrick Sequeira Roll No. 45 Jayesh Malwankar Roll No. 18 Norbert D Souza Roll No. 10 Bede Pereira Roll No. 35

Topics Covered 

Meaning of Credit Risk Evaluation and Assessment of Credit Risk Building Blocks for Credit Risk Management in Banks Evolution of Credit Risk Basel Committee Recommendations Future Trends in Credit Risk Management Case Study Conclusion

Main Bank Risks Credit Risk Interest Rate Market Risk Banking Risks Operational Liquidity Foreign Exchange Other Risks .

Meaning of Credit Risk  Credit risk is the possibility that a borrower or counterparty will fail to meet it s obligations in accordance with agreed terms  Credit risk is a commercial risk because it is business driven i. another bank. financial institution or a country  Credit risk benefits from diversification effect of the portfolio  Credit risk is invisible in nature and difficult to predict . the risk arises from a bank s dealings with or lending activities to a corporate. individual.e.

Forms of Credit Risk  Direct Lending Guarantees or Letters of Credit Treasury Operations Securities Trading Business Cross Border Exposure     .

Types of Credit Risk  TRANSACTION RISK ‡ Non-Payment of debt obligation ‡ Delay in payment of debt obligation ‡ Bankruptcy  PORTFOLIO RISK ‡ Grade risk ‡ Default risk ‡ Concentration risk ‡ Intrinsic risk .

Measurement of Credit Risk Standardized Approach Advanced Internal Rating Based Approach CREDIT RISK Foundation Internal Rating Based Approach .

recoveries under default Book values of loans. notional and mark-to-market values of derivatives Losses valued at book value or at mark-to-model values for migrations and default Correlation results from common factors influencing risk drivers and individual credit standing of borrowers Loss distribution under default mode only or under full valuation of migrations Value at Risk (VaR) from loss distribution    CORRELATIONS PORTFOLIO RISK CAPITAL   . default and migration probabilities.BUILDING BLOCKS : CREDIT RISK MANAGEMENT SYSTEM RISK DRIVERS RISK EXPOSURES STANDALONE RISK  Ratings.

a defaulter was tortured. imprisoned or forced into slavery along with his wife and children Modern Bankruptcy Law . make individuals. corporate entities and even nations slaves to their own debt Link to The International video    ..Evolution of Credit Risk  As per the Hammurabi Code .. a defaulter could be seized by his creditors and sold into slavery As per Biblical records . offers protection to a defaulter from creditors and extinguishes the debt obligation Modern Banking practices .......

which are then weighted according to the counter-party s risk weighting   .Cooke Ratio and Credit Risk  The 1988 Basel Accord required internationally active banks in the G10 countries to define a minimum capital level in relation to on and off-balance sheet assets (weighted values) Recommended that banks should hold capital equal to at least 8 per cent of weighted assets Requires a 2-step approach whereby banks convert their off-balance sheet positions into a credit equivalent amount through a scale of conversion factors.

50% Tier 1. min. fully paid-up) Subordinated debt (max. legal reserves ) ‡ ‡ ‡ ‡ ‡ Undisclosed reserves Asset revaluation reserves General provisions Hybrid instruments (must be unsecured.Cooke Ratio and Credit Risk DEFINITION OF CAPITAL Tier 1 ‡ Paid-up capital ‡ Disclosed reserves (retained profits. 5 years discount factor for shorter maturities) Tier 2 Deductions ‡ Goodwill (from Tier 1) ‡ Investments in unconsolidated subsidiaries (from Tier 1 and Tier 2) .

All other claims: claims on corporate.Claims on OECD banks and multilateral development banks .Mortgage Loans . claims on banks outside OECD with a maturity > 1 year.Claims on public sector entities (PSE) of OECD countries .Claims on banks outside OECD with residual maturity < 1 year .Cash .Claims on OECD central governments .Claims on other central governments if they are denominated & funded in the national currency (to avoid country transfer risk) . fixed assets.Cooke Ratio and Credit Risk RISK WEIGHT ASSETS Percentage 0 Items . all other assets 20 50 100 .

Forward purchased assets 50 100 .g.Sale and repurchase agreements . performance bonds) . 1 year Short-term self-liquidating trade-related contingencies (e.Undrawn commitments with an original maturity > 1 year .g. general guarantees of indebtedness ) .g. a documentary credit collateralized by the underlying goods) .Direct credit substitutes (e.Transaction-related contingencies (e.Cooke Ratio and Credit Risk CREDIT CONVERSION FACTORS (CCFs) Percentage Item 0 20 Undrawn commitments with an original maturity of max.

.. this unequal treatment creates arbitrage opportunities to reduce the capital load No allowance made for recoveries (if default occurs) Does not capture diversification effects    .Cooke Ratio and Credit Risk MAJOR STRENGTH : Simplicity of calculation MAJOR DRAWBACKS :  The absence of differentiation between the different risks of private corporations Short facilities have zero weights while long facilities have a full capital load .





potentially leading to insolvency  Banking institutions have always monitored credit risk actively through a number of systems such as limits. covenants. globalisation and privatization .Conclusion  Credit risk is the most important risk to which a bank is exposed  Credit risk management is critical since the default of a small number of important or high net-worth customers can generate large losses. internal ratings and watch lists  In an era of liberalisation. the diversification of the credit portfolio can reduce the size of loss (in the event of defaults) or can improve the shareholder s value  An effective credit risk management system pushes further away the frontier between measurable risks and invisible intangible risks as well as creates a link between risks and the sources of uncertainty that generate them . delegations...

funding it where it is cheapest & selling it where it is highly profitable. The risk management system of any financial institution should align itself to this.Thank You ´ Globalisation is nothing but producing a product which is cost effective. µ .

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