Modern Credit Risk Management

Theory and Practice

verfasst von: Panayiota Koulafetis

Verlag: Palgrave Macmillan UK

Enthalten in: Springer Professional "Wirtschaft+Technik" , Springer Professional "Wirtschaft"

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Über dieses Buch

Modern Credit Risk Management: From Theory to Practice is a practical guide to the latest risk management tools and techniques applied in the market to assess and manage credit risks at bank, sovereign, corporate and structured finance level. It strongly advocates the importance of sound credit risk management and how this can be achieved with prudent origination, credit risk policies, approval process, setting of meaningful limits and underwriting criteria.

The book discusses the various quantitative techniques used to assess and manage credit risk, including methods to estimate default probabilities, credit value at risk approaches and credit exposure analysis. Basel I, II and III are covered, as are the true meaning of credit ratings, how these are assigned, their limitations, the drivers of downgrades and upgrades, and how credit ratings should be used in practise is explained.

Modern Credit Risk Management not only discusses credit risk from a quantitative angle but further explains how important the qualitative and legal assessment is. Credit risk transfer and mitigation techniques and tools are explained, netting, ISDA master agreement, schedule and CSA, centralised counterparty clearing and margin collateral are all covered, as are overcollateralization, covenants and events of default. Credit derivatives are also explained, Total Return Swaps (TRS), Credit Linked Notes (CLN) and Credit Default Swaps (CDS). Furthermore, the author discusses what we have learned from the financial crisis of 2007 and sovereign crisis of 2010 and how credit risk management has evolved. Finally the book looks at the new regulatory environment, looking beyond Basel to the European Union (EU) Capital Requirements Regulation and Directive (CRR-CRD) IV, the Dodd–Frank Wall Street Reform and Consumer Protection Act.

This book presents a fully up to date resource for credit risk practitioners everywhere, outlining the latest best practices, and providing both quantitative and qualitative insights. It will be a welcome addition to any risk library, and is a "must-have" reference for credit risk practitioners.

Inhaltsverzeichnis

Frontmatter

Chapter 1: Introduction

Abstract

Credit, if managed prudently, can build an economy, produce an efficient allocation of capital and wealth and bring prosperity. It is an absolute must in the financial system, affects everyone and drives the global economy. Credit accommodates one of the main functions of financial markets, that of channelling funds from savers to spenders; it allows funds to move from people that lack productive investment opportunities to the ones that have such opportunities. Credit allows individuals to finance their needs of acquiring a house, car, furniture, etc., assists companies to start or expand their business, and enables governments to finance public interest projects such as utilities, schools, roads etc.

Panayiota Koulafetis

Chapter 2: Quantitative Credit Risk Analysis and Management

Abstract

One of the most important inputs in quantifying credit risk is estimation of the obligor’s Default Probability (DP). There are different approaches in the estimation of DPs and depending on the purpose of the analysis, these should be followed to best assess the credit risk.

Panayiota Koulafetis

Chapter 3: Credit Ratings: Credit Rating Agencies, Rating Process and Surveillance

Abstract

Credit rating agencies originated in the USA in the early 1900s. The construction of the railroad system led to the development of corporate bond issues in order to finance the work. Then ratings began to be applied to the issues. In Europe, the bond markets in the UK and the Netherlands were established earlier on but were much smaller and more focused on sovereign debt so that investors could trust that they would get their investment back. Following the 1907 financial crisis, there was increased demand for independent analysis of bond creditworthiness. In 1909, financial analyst John Moody issued a publication focused solely on railroad bonds. He was the first to introduce subscription fees to investors and his ratings were the first to be widely published. In 1913, his business expanded to include industrial firms and utilities. A few years later the antecedents of the largest rating agencies to date were established. Poor’s Publishing Company began issuing ratings in 1916, Standard Statistics Company in 1922 and the Fitch Publishing Company in 1924.

Panayiota Koulafetis

Chapter 4: Credit Risk Assessment of Sovereigns, Banks and Corporates

Abstract

National governments issue debt to obtain funding to finance public interest projects, such as transportation systems, hospitals, schools, utilities etc. Common debt issued consists of bonds, bills and notes. Typically bills mature in less than a year; notes have a maturity of one to 10 years and bonds 10 to 30 years. Sovereigns are the largest borrowers in the debt capital markets and their credit profile is used for benchmarking other debt issues.

Panayiota Koulafetis

Chapter 5: Credit Risk Assessment of Structured Finance Securities

Abstract

Securitization is the process of converting cash flows arising from underlying assets or debts (receivables), due to the originator into a repayment stream, thus enabling the originator to raise finance through the issue of securities. The portfolio of assets is “pooled” and transferred to a Special Purpose Vehicle (SPV), the issuer, a tax-exempt company or trust formed for the specific purpose of funding the assets. The arranger typically establishes the SPV. The issuer SPV issues securities in order to buy the assets from the originator. The investors purchase the securities, either through a private offering or on the open market. Once the assets are transferred to the issuer, there is normally no recourse to the originator (initial owner of the assets). The issuer is “bankruptcy remote”, meaning that if the originator goes into bankruptcy, the issuer’s assets will not be distributed to the originator’s creditors. In order to achieve this, the governing documents of the issuer restrict its activities to only those necessary to complete the issuance of securities. The performance of the securities is directly linked to the performance of the assets. Typically credit rating agencies rate the securities that are issued and provide their opinion on their creditworthiness (Diagram 1).

Panayiota Koulafetis

Chapter 6: Qualitative Credit Risk Analysis and Management

Abstract

This chapter discusses the main legal documents and legal considerations for credit risk analysis and management. It follows from the previous chapter and focuses on securitization types of transactions. However, the principles can be applied to other types of transactions, since the documents discussed, such as the offering circular, loan agreement, security related documents etc. are commonly used in the capital markets. Understanding the requirements for the appropriate legal documentation and further understanding and becoming familiar with the documents allows professionals to have an independent opinion of how transactions are structured and what the risk involved are. The most state of the art model will not be able to capture risks that could jeopardize a transaction and potentially an institution if the legal documents have been drafted poorly or do not express the commercial thought and intention of originators or the understanding of the credit risk managers and credit risk committees. When things go wrong quantitative models will not “save” a transaction, but well-drafted appropriate provisions in the legal documents may do! Therefore, it is very important that the intended commercial decision is expressed in the legal documents and, for this to occur, someone needs to review drafts, make comments, raise questions, work and liaise with lawyers, negotiate with other parties and make sure that the appropriate provisions, covenants, representations and warranties, and undertakings—among other things—protect their side of the transaction and their institution. Sound credit risk management starts while the transaction is being originated and negotiated; after closing the only thing that can be done is to monitor it. It is actually the terms that have been negotiated and are part of the binding legal documents that allow more flexibility to better manage the transaction after closing!

Panayiota Koulafetis

Chapter 7: Credit Risk Transfer and Mitigation

Abstract

Financial institutions have throughout time developed several different methods to mitigate and transfer credit risk. These include letters of credit and guarantees, covenants, marking to market, netting central counterparty clearing, collateralization and over-collateralization, syndication, early transaction termination, credit derivatives and securitization. Credit derivatives and securitization are the most sophisticated, flexible and can separate and redistribute credit risk to a very broad class of financial institutions. Securitization and credit derivatives have received a lot of criticism following the 2007 financial crisis. However, these are very powerful tools for credit risk transfer and mitigation. They should be understood before they are used, and used not in excess but with care and caution. If they are used appropriately they can effectively assist in credit risk transfer, mitigation and management, but if they are abused and their dynamics not understood they can have a devastating impact on the economy.

Panayiota Koulafetis

Chapter 8: Regulation

Abstract

Banks are regulated by different local regulatory bodies according to their jurisdiction. Although there are international regulation standards, these are implemented by local regulators. International banks operate in various jurisdictions, and are subject to supervision by their home regulatory supervisor as well as by the local/host regulatory supervisor in countries where they have operations. The new Basel Accords require close practical cooperation of the home and host regulatory supervisors in order to reduce the supervisory burden on international banks.

Panayiota Koulafetis

Backmatter

Titel: Modern Credit Risk Management
verfasst von: Panayiota Koulafetis
Verlag: Palgrave Macmillan UK
Electronic ISBN: 978-1-137-52407-2
Print ISBN: 978-1-137-52406-5
DOI: https://doi.org/10.1057/978-1-137-52407-2