Credit Risk

Credit Risk

1. Default Risk

   • Lending R/S
   • Failure to pay principle / coupon
   • Eg. Loan

2. Counterparty Risk

   • Failure to perform which lead to loss
   • Contractual based

3. Risk Management

   • How business risk are monitored and controlled

4. RIsk

   • The possibility of loss due to uncertainty about the future

5. Retail vs Commercial

   • Credit Scoring Models
     • Credit Bureau Scores
       • Generic Credit Scores
         • Generic Information
           • Identifying Info
           • Public Records (Legal)
           • Collection Info
           • Trdae Line
           • Inquiries
       • Broad overview of overall credit worthiness
     • Pooled Models
       • Tailored to industry
     • Custom Models
       • Tailored to company
     • Higher the score, Lower the risk
       • Cheap & Consistent Process
     • Increase the profitability of bank
       • Adverse Selection
         • Avoid Default
         • Avoid Losses
       • Manage Customer R/S cycle
         • Market New Product
           • Help cust grow their wealth
             • So can invest more = loan out more = earn i/r = earn $$$
         • Manage R/S
           • Know when they will default
     • Trade-off between profitability & risk of default
       • Bad Cust may qualify
       • Good Cust may be rejected
   • Commercial Credit Risk Scoring
     • Credit Rating System
       • put everything tgt to allow comparison
         • Through Time
         • Across Firm
       • Internal Risk Rating System
         • Purpose
           • Operational Rules
             • Accept or Reject new trasactions
             • Monitor Credit Quality
             • Pricing & trading of loans
           • Capital Rules
             • Attribution of economic capital by shareholders
             • Loan Loss Reserve enough?
             • Adequacy of capital
         • Basel
           • global regulatory body for the banks
           • Need meet 6 Condition to use own IRR
             • Why need use own IRR
               • compete with other bank by giving lower interest rate
             • Be able to differentiate high/ low risk
               • categorize into table to decide the ranges and what range what i/r
             • Bank's rating consistent
               • Across Time, Across People
             • Risk rating assignment well documented
             • Risk Quantification & Back Testing
               • Using of historical data to test the % given.
               • Disadvantage: back testing assume all things stay constant and future will be similar but it is not realistic but logical.
       • External Risk Rating System
         • Rating Agencies
           • Standard & Poor's
           • Moody's
         • Financial Ratios
           • Refer to paper behind
         • Rating Process
           • Quantitative
           • Qualitative
           • Legal Analyses

6. Factors Affecting

   • Creditor Quality
   • Diversification
     • Number
     • Industry
     • Geography
   • State of economy
   • Maturities of Loan

7. Credit Protection

   • Bond Insurance
   • Gurantees
   • Collateral
   • Early Termination
   • Reassignment
   • Netting
   • Mkt to Mkt
   • Put Options

8. Securitization

   • Transfer Credit Exposure to investors
   • Provide Loans then sell to govt agency to be further distributed by investment banks who give advices
     • Invst Bank pay rating agencies to rate the loans
       • Then was sold to investors
         • Buy CDS to protect themselves
           • CDS sold by AIG
           • Type of insurance
           • If loan default, AIG gurantee to pay back in full for a monthly premium

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