Credit Risk Management

IntroductionManaging Individual Credit Risks

Motivation and Objectives

Dr. Nizar Atrissi

Why Risk Management?

For the CompanyPreserve Value Create Value Optimize Capital

For the MarketInstill Market Confidence Prevent Stock Market Volatility

For the EconomyPreserve Macroeconomic StabilityIncrease Credit Flows for Increased Growth

Why Risk Management?

Serious Consequences for all economic agents

the current financial market turbulence underscores the importance of getting the fundamentals of sound risk management right and being ever vigilant about their consistent application, execution, and improvement in light of new data and experiences.

Defaults on subprime loans and excessive debt burdens have supplanted terrorism as the biggest threat to the U.S. economy, survey of economists by the National Association for Business Economics.

Key Organizational Questions in Risk Management

How good is the judgment of the current credit officers?What is the quality and availability of the information

(financial and nonfinancial) that can be used to assess risk quantitatively?

What financial and human resources are available?What is the state of competition and structure of

economy?The response to these questions determine

Adapting contemporary methods to local needs and reality (e.g. credit scoring system, quantitative risk methods, delegation of powers etc.) The type of due diligence system to be developed.

Credit risk definition The potential for loss due to failure of a borrower to

meet its contractual obligation to repay a debt in accordance with the agreed terms

Example: A homeowner stops making mortgage payments

Commonly also referred to as default risk Credit events include bankruptcy, failure to pay, loan

restructuring, loan moratorium, accelerated loan payments

For banks, credit risk typically resides in the assets in its banking book (loans and bonds held to maturity)

Credit risk can arise in the trading book as counterparty credit risk

Credit Cycle and Risk AssessmentRisk IdentificationYou cannot manage your risks if you do not know what they are.Risk MeasurementTimely, accurate, consistent and reliable informationRisk ControlYou control what you cannot measureRisk limits, operating within limits. Financial analysis and models, supported by market analysis.Risk ReportingTo marketsTo Regulators

Basic ObjectivesCredit vocabulary, the process of business & industry analysis, the calculation of historical financial ratios, and the analysis of both historical ratios and cash flowIntegrate financial, cash flow and collateral analysis, management assessment, business and competitive environment analysisPerform historical and trend analysis Measure the impact of management decision-making on financial performance. Identify the different types of credit risk and how they arise in different activities Integrate financial analysis, management assessment, and business environment into an appropriate credit recommendation. Understand how credit risk can be quantified, monitored and controlled and the role of credit portfolio management toolsAppreciate how capital is allocated against risk (under Basel for example)

Basic Principles

Explicit statement of policy, which clearly states the organization's appetite for risk Targeted goals for portfolio mix. Appropriate policies, systems, and controls should govern the identification, measurement, monitoring, andControl of credit risk concentrations. Concentration limits defined in relation to capital, total assets, and, where available, overall risk exposure.

Basic Tools

Use of Primary and Secondary SourcesFinancial Statement Analysis, including the following:- Ratio Calculation and Analysis: Profitability, Asset Efficiency, Liquidity, Debt Service, and Coverage, Leverage & Capital Structure, PerformanceThe Impact of Accounting MethodsOff Balance Sheet ConsiderationsPeer Analysis, Trend Analysis, Industry BenchmarksCash Flow Analysis

Basic Credit Risk Assessment Modules

Ratio Analysis section - An explanation of the calculation and interpretation of critical financial ratiosCash Flow Analysis section Projections and the Credit Decision section technique for projecting a company's future financial performance to determine its potential and ongoing credit risk.Quantitative Risk Assessment exposure to quantitative risk analytics and modelsQualitative Risk AssessmentAssessing Management Risk --- assessment of financial impact of management decisions, integrity and skillsSignaling to Regulators