Overview of Credit Marketing

Risk Management st Half 2009

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 obligors failure to meet its obligations in accordance with
the agreed terms

Goal of CRM: maximization of the banks 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 banks 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 Set objectives

provisions; and
capital charges responsibilities

Monitor credit
performance Set credit risk
guidelines

Make credit
decisions Collect credit
Measure and data
assess credit
risk
 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;

Borrowers repayment history and current capacity to repay,

based on the historical trends in its financials and future cash flow
projections, under various scenarios; customers 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 Facility risk related

Probability of Loss Exposure

Expected X X
= default given
loss at default
(%) default
 Overview of Credit Risk Management practices in banks
Usage of Credit Ratings

Portfolio Management
Rating based pricing
scenario analysis
default rate, recovery
rate risk based exposure limits
Rating system
expected loss charge,
capital charge
 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)