Credit Risk

CAIIB
Bank Financial Management
Module B
Risk Management
Prepared By: Jagat Nagar (M : 9909792440)
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Credit Risk

Credit risk arises from lending activities of a bank.

It arises when borrower does not pay interest and/or installment
The borrower fails to make the payment as and when demanded.
Credit Risk management frame work divided in 4 parts.
1. Credit risk identification
2. Credit risk Measurement
3. Credit risk Monitoring and control
4. Credit risk Mitigation.

Prepared By: Jagat Nagar (M : 9909792440)

- jagatnagar@yahoo.co.in

Credit Risk
Organisation structure:
a. The Board of Directors.
b. The Risk Management Committee
c. Credit policy committee (CPC)
d. Credit Risk Management Department
1. Credit risk Identification: There are main 2 types of risk
a. Transaction Risk
b. Portfolio Risk
Prepared By: Jagat Nagar (M : 9909792440)
- jagatnagar@yahoo.co.in

Credit Risk
a. Transaction Risk
- Default Risk : This risk is failure of a borrower to make
promised payments, either partly or wholly.
- Downgrade Risk or Credit Spread Risk: If borrower does not
default, there is still risk due to worsening in credit quality.
This results in the possible widening of the credit-spread.
It is reflected through rating downgrade.
It is normally firm-specific.
b. Portfolio Risk
- Systematic or Intrinsic Risk: In portfolio, risk is minimum but
minimum level corresponds to the risks in the economy in
which it is operating. This is sytemetic or intrinsic risk.
Prepared By: Jagat Nagar (M : 9909792440)
- jagatnagar@yahoo.co.in

Credit Risk
- Concentration Risk: If the portfolio is not diversified that is
to say that it has higher weight in respect of a borrower or
geography or industry etc. the portfolio gets concentration risk.
- Counterparty Risk: It arises from non-performance of the
trading partners. It may arise from counterparty's refusal /
inability to perform.
- Country Risk: It is also a type of credit risk where nonperformance by borrower or counterparty arises because of
restrictions imposed by a sovereign. The restrictions by
government or may arise due to economic conditions.
Prepared By: Jagat Nagar (M : 9909792440)
- jagatnagar@yahoo.co.in

Credit Risk
Risk Measurement: Risk measurement of credit risk consists of
(a) Measurement of risk through credit rating/scoring credit rating
exercise seeks to predect whether the borrower would have
the capacity to honour its financial commitment in future to the
rest of the world.
Rating migration is change in the rating of a borrower over a
period of time when rated on the same standard or model.
(Pg. No.- 264)
(b) Qualifying the risk through estimating expected loan losses.
Prepared By: Jagat Nagar (M : 9909792440)
- jagatnagar@yahoo.co.in

Credit Risk
Altman develop model combines 5 financial ratios to measure of
borrower's financial health (Pg. No.283 - formula).
J.P.Morgan has developed a portfolio modelcalled 'CreditMatrics
for evaluating credit risks.
Credit suesse developed a statistical method for measuring and
accounting for credit risk which is known as CreditRisk+.
Credit Risk Control and monitoring:
- Credit Appraisal process
- Risk Analysis Process
- Credit Audit and Loan Review
- Monitoring Process
Prepared By: Jagat Nagar (M : 9909792440)
- jagatnagar@yahoo.co.in

Credit Risk

Credit Risk Mitigation:

a. Securitisation
b. Collatealised Loan Obligations: (CLOs)
c. Credit Derivatives

Prepared By: Jagat Nagar (M : 9909792440)

- jagatnagar@yahoo.co.in

Credit Risk
a. Securitisation: Securitisation refers to a transaction where
financial securities are issued against the cash flow generated
from a pool of assets.
b. Collatealised Loan Obligations: (CLOs)These are securitised pools of commercial loans.
The CLO usually resides in an SPV (Special purpose Vehicle)
c. Credit Derivatives:
It transfer risks in credit assets without transferring the
underlying assets themselves from the books of the originator.
These are off-balance sheet financial instrument.
Prepared By: Jagat Nagar (M : 9909792440)
- jagatnagar@yahoo.co.in

Credit Risk

Thank You

Prepared By: Jagat Nagar (M : 9909792440)

- jagatnagar@yahoo.co.in

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