CREDIT RISK MANAGEMENT

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Presentation transcript:

CREDIT RISK MANAGEMENT THE COMMODITISATION OF CREDIT RISK TRENDS IN CREDIT RISK MANAGEMENT

KEY PROPOSITION THE ADVENT OF ACTIVE AND LIQUID CREDIT TRADING WILL REQUIRE COMPLETE RE-ENGINEERING OF THE CREDIT FUNCTION & PROCESS ALTER THE NATURE OF BANKING FUNDAMENTALLY

AGENDA KEY DRIVERS OF CHANGE CREDIT RISK MANAGEMENT PARADIGMS CLASSICAL MODERN CREDIT RISK MANAGEMENT ARCHITECTURE IMPLICATIONS FOR FINANCIAL SERVICES

KEY DRIVERS OF CHANGE KEY FEATURE OF CREDIT RISK CENTRAL TO ALL FINANCIAL TRANSACTIONS TRADITIONAL VIEW OF CREDIT ILLIQUID CURRENT VIEW OF CREDIT LIQUID & TRADEABLE SHIFT FROM STATIC MANAGEMENT OF CREDIT TO DYNAMIC MANAGEMENT OF CREDIT RISK

KEY DRIVERS OF CHANGE SHAREHOLDER VALUE ISSUES RETURN ON CREDIT CAPITAL OPTIMISATION OF RETURN ON CREDIT CAPITAL CHANGES IN FINANCIAL SERVICES VALUE CHAIN IN FINANCIAL SERVICES TREND TO UNBUNDLING THE MICROSTRUCTURE

PRODUCT FOCUS CLIENT FOCUS PRODUCT/ KNOWLEDGE MANAGEMENT CAPITAL MANAGEMENT RISK MANAGEMENT TECHNOLOGY MANAGEMENT RISK ORIGINATION/ DISTRIBUTION PRODUCT MANUFACTURE PROCESSING/ ADMINISTRATION PRODUCT FOCUS CLIENT FOCUS

KEY DRIVERS OF CHANGE CREDIT RISK MANAGEMENT PERFORMANCE CONTROL FAILURES QUANTIFICATION OF CREDIT RISK INTERACTION OF MARKET AND CREDIT RISK CREDIT RISK PRICING INABILITY TO PRICE CREDITR ISK “CORRECTLY” INCONSISTENCY OF PRICING

KEY DRIVERS OF CHANGE COSTS OF CREDIT RISK MANAGEMENT INFRASTRUCTURE LIQUEFACTION OF CREDIT RISK SYNDICATION & ASSET SALES SECURITISATION CREDIT DERIVATIVES & CREDIT LINKED NOTES

KEY DRIVERS OF CHANGE DEVELOPMENTS IN CREDIT ENHANCEMENT TECHNIQUES BI-LATERAL MULTILATERAL ADVANCES IN CREDIT/ DEFAULT RISK THEORY INFRASTRUCTURE DEVELOPMENTS SYSTEMS CAPABILITIES

KEY DRIVERS OF CHANGE CHANGE IN REGULATORY FRAMEWORK SHIFT TO CAPITAL BASED REGULATION REGULATORY ARBITRAGE (POSSIBILITY) OF MODEL BASED CREDIT RISK CAPITAL

KEY DRIVERS OF CHANGE KEY NEAR TERM FACTORS CREDIT CAPITAL MANAGEMENT CREDIT PRICING CREDIT RISK MANAGEMENT REGULATORY DEVELOPMENTS SHIFTS IN BANKING STRATEGY

CREDIT RISK PARADIGMS TYPES CLASSICAL MODERN KEY ISSUE APPLICABILITY TO DIFFERENT MARKET SEGMENTS

CREDIT RISK BY MARKET SEGMENT SEGMENTS RETAIL MID-MARKET WHOLESALE/ CORPORATES DIMENSIONS RISK PRICING CREDIT METHODOLOGY LIQUIDITY AND TRADEABILITY

NUMBER OF COUNTERPARTIES SIZE OF INDIVIDUAL EXPOSURE LARGE RETAIL MID-MARKET NUMBER OF COUNTERPARTIES WHOLESALE SMALL HIGH LOW SIZE OF INDIVIDUAL EXPOSURE

CLASSICAL PARADIGM CONCEPT ASSESS RISK AND MATCH WITH CAPITAL RISK MANAGEMENT TECHNIQUES DIVERSIFICATION COLLATERAL SCHEMATIC

CREDIT RISK MANAGEMENT CAPITAL PROVISIONING RISK SYNDICATION CREDIT RISK MANAGEMENT CREDIT REQUEST TRANSACTION CREDIT FUNCTION ORIGINATION CLIENT CREDIT LIMIT TRANSACTION ORIGINATION PREPARATION OF CREDIT REQUEST PRICING/ STRUCTURING ADMINISTRATION CREDIT ASSESSMENT MONITORING CREDIT LIMIT & CREDIT ADMINISTRATION

CLASSICAL PARADIGM KEY ELEMENTS CREDIT ANALYSIS AND ASSESSMENT PROCESS

IMPLICATIONS OF CLASSICAL PARADIGM CREDIT RISK ASSUMPTION CREDIT PRICING CREDIT CAPITAL MANAGEMENT CREDIT RISK FOCUS CHANGES IN CREDIT QUALITY PERFORMANCE ATTRIBUTION OF ORIGINATORS PERFORMANCE OF CREDIT FUNCTION

MODERN PARADIGM CONCEPT CREDIT RISK AS A SEPARATE TRADEABLE ASSET CLASS RISK MANAGED DYNAMICALLY THROUGH HEDGING AND TRADING TOOLS SCHEMATIC

CREDIT PORTFOLIO MANAGEMENT & POSITIONING TRANSACTION TRANSACTION ORIGINATION STRUCTURING/ PRICING ADMINISTRATION ORIGINATION CLIENT CREDIT REQUEST CREDIT LIMIT & CREDIT CHARGE CREDIT FUNCTION CREDIT ASSESSMENT CREDIT PORTFOLIO ANALYSIS CREDIT CAPITAL MANAGEMENT SYNDICATION/ ASSET SALES SECURITISATION CREDIT DERIVATIVES CREDIT TRADING CREDIT PORTFOLIO CREDIT PORTFOLIO MANAGEMENT & POSITIONING CREDIT CAPITAL CAPITAL MARKET

CREDIT RISK ASSUMED & MANAGED CREDIT CAPITAL TRANSACTION CREDIT RISK INTERNAL CREDIT DEFAULT SWAP CREDIT RISK CREDIT PORTFOLIO TRANSACTION ORIGINATOR RETURN CREDIT RISK CHARGE CREDIT HEDGES CREDIT RISK TRADED & HEDGED

MODERN PARADIGM KEY ELEMENTS CREDIT ANALYSIS AND ASSESSMENT PROCESS

IMPLICATIONS OF MODERN PARADIGM CREDIT RISK ASSUMPTION CREDIT PRICING CREDIT CAPITAL MANAGEMENT CREDIT RISK FOCUS CHANGES IN CREDIT QUALITY PERFORMANCE ATTRIBUTION OF ORIGINATORS PERFORMANCE OF CREDIT FUNCTION

IMPLICATIONS OF MODERN PARADIGM CLIENT MANAGEMENT CORE VERSUS NON CORE CLIENTS HOME VERSUS FOREIGN MARKETS

CREDIT RISK MANAGEMENT ARCHITECTURE CONCEPT RISK MANAGEMENT SYSTEMS COMPONENTS INFORMATION SYSTEMS SCHEMATICS

CREDIT EXPOSURE - STATIC & DYNAMIC (PFCE MODEL) DEFAULT PROBABILITY/ RATINGS MIGRATION RECOVERY RATES DEFAULT CORRELATIONS PORTFOLIO MODELS PRICING MODELS RATING MODELS INTERNAL EXTERNAL CREDIT ANALYSIS CREDIT MODELS RISK DATA TRANSACTION DATA CREDIT DATA COLLATERAL NETTING CLEARING HOUSE OBLIGOR/ COUNTERPARTY DATA CREDIT ENHANCEMENT ECONOMIC CAPITAL REGULATORY CAPITAL PROVISIONING CREDIT CAPITAL MANAGEMENT LIMIT ADMINISTRATION REPORTING SETTLEMENT LIMITS RISK LIMITS

IMPLICATIONS FOR FINANCIAL SERVICES TYPES MICRO(OPERATIONAL) REDEFINITION OF CREDIT PROCESS WITHIN ORGANISATIONS MACRO(STRATEGIC) REDEFINITION OF BUSINESS FOCUS

OPERATIONAL CHANGES RE-ENGINEERING THE CREDIT PROCESS ALTERATION OF CREDIT RISK ARCHITECTURE/ INFRASTRUCTURE

STRATEGIC CHANGES THEME SHIFT FOCUS OF BANKS FROM HOLDER OF RISK TO ORIGINATORS AND DISTRIBUTORS OF RISK MODELS OF BANKING PRACTICE

MODEL 1 - CLASSICAL BANKING MODEL LOAN TRANSACTION DEPOSIT TRANSACTION DEPOSITOR BORROWER BANK BANK ORIGINATES, FUNDS, ADMINISTERS AND RETAINS CREDIT RISK OF BORROWER

MODEL 2 - INVESTMENT BANKING/ SECURITIES MODEL ISSUE OF SECURITIES DISTRIBUTION OF SECURITIES INVESTOR BORROWER BANK UNDERWRITING OF PLACEMENT OF SECURITIES AND SYNDICATION OF UNDERWRITING RISK OTHER BANKS BANK ORIGINATES TRANSACTION AND MAY ADMINISTER IT AS PAYMENT AGENT. FUNDING AND CREDIT RISK OF BORROWER IS TRANSFERRED TO INVESTOR. PRIMARY RISK IS UNDERWRITING WHICH IS SYNDICATED TO REDUCE RISK LEVEL,

MODEL 3 - SECURITISATION MODEL SALE OF LOAN BACKED SECURITIES LOAN TRANSACTION SECURITISATION VEHICLE BORROWER BANK INVESTOR SALE OF LOAN TO SECURITISATION VEHICLE BANK ORIGINATES AND ADMINISTERS THE LOAN. BANK SELLS LOAN TO SECURITISATION VEHICLE WHICH ISSUES LOAN ASSET BACKED SECURTIES. FUNDING AND CREDIT RISK OF BORROWER IS BORNE BY INVESTOR. BANK RISK IS CONFINED TO CREDIT RISK PRE-SALE TO SECURITISATION VEHICLE AND ANY UNDERWRITING RISK ON THE PLACEMENT OF THE LOAN ASSET BACKED SECURITIES

MODEL 4 - ECONOMIC RISK TRANSFER MODEL LOAN TRANSACTION CREDIT DEFAULT SWAP OR CREDIT LINKED NOTE INVESTOR/ OTHER BANK BORROWER BANK BANK ORIGINATES, FUNDS AND ADMINISTERS THE LOAN. CREDIT RISK OF BORROWER IS TRANSFERRED TO INVESTORS OR OTHER BANKS. BANK CREDIT RISK IS PRE ECONOMIC HEDGE ONLY. WHERE A CREDIT LINKED NOTE IS ISSUED THE INVESTOR/ OTHER BANK ALSO PROVIDES FUNDING.

KEY CHALLENGES CREDIT RISK MODELLING PROBLEMS DEVELOPMENT OF CREDIT TRADING CREDIT ENHANCEMENT PROBLEMS CHANGES IN CREDIT INFRASTRUCTURE CHANGE MANAGEMENT

CONCLUSIONS THE ADVENT OF ACTIVE AND LIQUID CREDIT TRADING WILL REQUIRE COMPLETE RE-ENGINEERING OF THE CREDIT FUNCTION & PROCESS ALTER THE NATURE OF BANKING FUNDAMENTALLY