st Half 2009
Overview of Credit Marketing
Risk Management
Report 1practices
in banks
Overview of Credit Risk
Management practices –
The banking perspective
Sofia
December 2, 2010
Overview of Credit Risk Management practices in banks
Basic concepts of the credit risk management
Credit Risk is the current or prospective risk to earnings and capital,
arising from an obligor’s failure to meet its obligations in accordance with
the agreed terms
Goal of CRM: maximization of the bank’s risk adjusted rate of return by
maintaining credit risk exposure within acceptable parameters
CRM refers to the credit risk in individual credits or transactions as
well as the risk inherent in the entire portfolio
Consideration of the relationship between credit risk and other risks
The CRM approach used by individual banks should correspond to
the scope and sophistication of the bank’s activities
Overview of Credit Risk Management practices in banks
Main principals for credit risk management
Lines of defence in the credit risk management process
•
First line is considered Business origination units (business units).
They are obliged to follow strictly the principles and rules defined in the
Lending Rules and Credit Policy of the bank and to assess the credit
risk in a manner of keeping the interests of the Bank.
•
Second line is considered Credit Risk units (decision takers with credit
approval competences). They are responsible for the precise and in
depth assessment and approval of credit risks to different customer
types of borrowers and the adherence to the approved Credit Policy of
the bank.
•
Third line is considered the Risk management unit. It is responsible for
identification of treats against the overall credit portfolio, i.e. monitoring
of existing credit risks within the portfolio and identification of potential
credit risks that could evolve.
Overview of Credit Risk Management practices in banks
Credit risk process & credit risk management
Allocate
provisions;
capital charges
Monitor credit
performance
Set objectives
and
responsibilities
Set credit risk
guidelines
Make credit
decisions
Measure and
assess credit
risk
Collect credit
data
Overview of Credit Risk Management practices in banks
Broad principles of credit risk management in Banks
Best practices in credit risk management in the following areas
Establishing an appropriate credit risk environment
Operating under a sound credit granting process
Maintaining an appropriate credit administration, measurement
and monitoring process
Ensuring adequate controls over credit risk
Role of bank supervisors in ensuring that banks have an
effective system in place to identify, measure, monitor and control
credit risk
Overview of Credit Risk Management practices in banks
Important factors for credit approval
Purpose of the credit and source of repayment;
Current risk profile (incl. the nature and aggregate amounts of risks)
of the borrower or counterparty and its sensitivity to economic and
market developments;
Borrower’s repayment history and current capacity to repay,
based on the historical trends in its financials and future cash flow
projections, under various scenarios; customer’s capacity to increase
its level of indebtedness;
The proposed terms and conditions of the credit, including
covenants designed to limit changes in the future risk profile of the
borrower;
Proposed collateral types, LTV, adequacy and enforceability of
collaterals or guarantees, under various scenarios;
Integrity and reputation of the borrower or counterparty.
Overview of Credit Risk Management practices in banks
Specific factors for credit approval for business customers
Internal factors
 Financial risk
 Assessment of the existing financial position
 Assessment of the expected financial position
 Accounting quality
 Business risk
 Market position
 Operating Efficiency
 Management risk
 Management business expertise
 Payment record
External factors
 Conditions in the respective economic sector of activity
 Economic trends in the industry of activity
Overview of Credit Risk Management practices in banks
Credit risk assessment tools
Expert judgment
Based on assessment of factors like: the features of the credit
facility, the capital position (incl. capital structure) of the applicant,
its repayment capacity, the collateralization, the economic
conditions and the business cycle on the respective market
Credit rating systems
Capture all relevant information about the borrower and assign a
grade through a risk rating process, by the consideration of
financial and non-financial factors
Limits system
Prudential regulations for single borrowers/related parties, risk
class/rating linked exposures, industry level caps, delegation of
powers
Overview of Credit Risk Management practices in banks
Roles of Credit ratings
Rating represents the default probability
Role in approval process
 depends on the risk appetite (minimum rating criterion)
 capital allocation (pricing)
Role in monitoring, analysis and reporting
 indicates the quality of the exposure at a given moment of time
 should be linked to the periodicity of the asset review process
 early warning system
 capture asset quality migrations
 product pricing (Risk Return trade-offs)
 provisioning and capital requirements
Administration
 Loan review/monitoring
 Trigger Actions (i.e. planning credit enhancement, reduction in exposures, exit strategy)
Overview of Credit Risk Management practices in banks
Quantitative approach for credit risk measurement
Borrower risk
Expected
loss
=
Probability of
default
(%)
Facility risk related
X
Loss
given
default
X
Exposure
at default
Overview of Credit Risk Management practices in banks
Usage of Credit Ratings
Rating based pricing
• default rate, recovery
Rating system
rate
• expected loss charge,
capital charge
Portfolio Management
• scenario analysis
• risk based exposure limits
Overview of Credit Risk Management practices in banks
Approaches to Credit Risk Management
Credit risks are managed at the level of the Obligor Group
Concentration Risk, as part of credit risk, includes:
 large (connected) individual exposures and
 significant exposures to groups of counterparties whose likelihood of
default is driven by common underlying factors, e.g. economic sector
(industry), geographical location, currency, credit risk mitigation techniques
(including, for example, risks associated with large indirect credit exposures
to a single collateral issuer)