FINS3634

Lecture Dr Thuy-Duong To (Twee)

Contact via Moodle discussion board
Consul time 2-3 Wednesday ASB Lvl 3 Room 359B (East wing)
Assessment:
Group pres 15% (start week 7) 4-5 students
Debate participation 5%
Group Assignment 20% week 10 (Tue) 4-5 students doesnt have to be same
group
Final exam 60% MC short answer
Dont need textbook

Intro and Credit Risk Management

Is a paper loss important??

(conceptional loss) paper loss increases the risk of the actual money not
being paid back (default risk increases)
if you need liquidity you have to sell the credit for less paper loss becomes
real

Credit market has grown

Financial deepeningo Loan to value ratio increased, people with access to credit can
access more credit
o More people can access credit
Normal structural upturns
o Markets (ie real estate) doing well, economic improvement (ie less
unemployment) makes people become more relaxed to credit
Excessive structural movements
o Good economy means more credit which may cause a bubble

Rating drift- rating upgrade rate minus the rating downgrade rate in a given year
( a measure of trends in average credit quality)
Surge in market interest in measuring and managing credit risk

Increases in bankruptcies
Disintermediation- stream lining process involving intermediaries (in credit
case it is the bank), can issue bonds (borrow without bank), peer to peer
lending.
More competitive margins- if margin is small any real default can affect
you badly, offer loan to riskier client
Declining and volatile value of collaterals- during crisis, assets not
sufficient to cover debt, hard to manage risk if volatility high

The growth off-balance-sheet derivatives- not nessarily bad but are used
incorrectly or very riskily
Technology- easier to manage credit risk, more data easier to analyse
The BIS Risk-Based Capital Requirements- require bank to have capital
buffer for their credit risk, good model can save on capital, tailor your
model to lower risk (compared to an umbrella approach), incentive for
bank to develop efficient models of credit risk

Quantify credit risk

Default probability (PD)

Recovery rate= 1 LGD (loss given default)
Size of outstanding credit- exposure at default
Expected loss = Exposure*PD*(1-recovery rate)

Lending
Objectives

Move money from surplus units to real production units that will add to the
economy
Continuous measuring of risk is a big part now, not just when loan is first
made

Assessment of borrowers Character (past behaviour) (one of the 4 Cs)

Examples for retail customers- late payment, delinquent accounts,

stability. Level of education and experience etc.
Examples for commercial customers- managerial experiences, business
practice (ethical, sustainable) disclosure record, media coverage etc.

Assessment of borrowers Capacity (looking forward, ability to repay debt) (one of

the 4 Cs)

Examples for retail customers- debt vs income, work experience (length of

employment) etc.
Examples for commercial customers- cash flow ( company may be
profitable but that must become real money), strength of balance sheet,
profitability, Financial flexibility (if company gets in trouble to their
structure etc allow adjustment)