The Reform of Regulatory Capital The Challenges of the New Proposal - PowerPoint PPT Presentation

1 / 25
About This Presentation
Title:

The Reform of Regulatory Capital The Challenges of the New Proposal

Description:

Default rates Obligor s internal credit risk rating. Default horizon Typically 1 year ... most internal rating systems, key criterion is internal credit risk rating ... – PowerPoint PPT presentation

Number of Views:35
Avg rating:3.0/5.0
Slides: 26
Provided by: cbme1
Category:

less

Transcript and Presenter's Notes

Title: The Reform of Regulatory Capital The Challenges of the New Proposal


1
Risk-Focused Supervision.How is Risk Defined?
Financial Stability Institute and the Committee
of Banking supervisors of West and Central
Africa 8-12 April 2002
Jean-Philippe Svoronos Basel Committee on Banking
Supervision
2
Overview
  • Risks in Banking proportions
  • Risks in Banking definitions.
  • Risk Factors The Example of Credit Risk
  • Risk management Credit Risk

3
1. Risks in Banking
  • A bank that does not take risk is not a bank
  • Banks survive by accepting risks and prosper by
    managing them adequately
  • Risk taking is banks crucial economic role and
    the reason for their existence
  • But adequate management of risks has, over
    time, become more difficult and complex

4
1. Risks in Banking proportions
  • Banking risks
  • Credit Risk
  • Default risk
  • Country Risk
  • Settlement risk
  • Market Risks
  • Liquidity Risk
  • Interest Rate Risk
  • Operational risk
  • Reputational Risk

5
1. Why is Credit Risk So Important?
  • Credit risk continues to be the primary source of
    problems at banks
  • Implying that most banks that have gone under
    were hit by credit risk
  • The effective management of credit risk is
    essential to the long-term success of any bank

6
2. Risks in banking what is Credit Risk?
  • Credit risk is most simply defined as the
    potential that a banks borrower or counterparty
    will fail to meet its obligations in accordance
    with agreed terms.
  • Credit risk exists throughout the activities of a
    bank
  • Loans are the largest and most obvious source
  • Credit risk exists in both the banking and
    trading book
  • Credit risk exists on and off balance sheet

7
2. Risks in Banking What is Market Risk?
  • Risk of losses in on-balance sheet and
    off-balance-sheet positions arising from
    movements in market prices.
  • Examples
  • Interest rate risk
  • Foreign exchange risk
  • Equity position risk
  • Commodity position risk

8
Credit risk and market risk comparedReturn
distributions
  • Market risk is significantly different in nature
    from credit risk
  • Credit returns are skewed, with a long fat tail
  • Market returns are normally distributed
    (bell-shaped)
  • Market risks
  • Often highly correlated
  • Can be reduced through hedges
  • Can only be slightly reduced through
    diversification
  • Credit risk
  • Less correlated
  • Can be reduced though diversification
  • Hedges (i.e. credit derivatives) still in state
    of development

9
Typical Distribution of Credit Returns
Gains
Losses
10
Typical Distribution of market returns
Losses
Gains
11
2. Risks in Banking What is Liquidity Risk?
  • The ability for a bank to fund increases in
    assets and meet obligations/payments as they come
    due.
  • Sound liquidity management one of the most
    important activities conducted by a bank
  • The importance of liquidity transcends the
    individual bank a liquidity shortfall at a
    single institution can have system-wide
    repercussions.

12
2. Risks Overall Interest Rate Risk?
  • The interest rate risk of a bank resulting from
    its global position.
  • Such a position is the result of aggregating all
    the individual positions that a bank takes when
    entering into transactions, whether on
    balance-sheet (assets and liabilities) or
    off-balance sheet.
  • Its management is sometimes associated with
    managing liquidity, although the risks are not
    the same.

13
2. Risks in Banking Operational risk
  • An area of risk on which both banks and
    supervisors are increasingly focusing because of
    its relative importance.
  • No single definition available.
  • Definition of New Basel Accord is partial risk
    of loss resulting from inadequate or failed
    internal processes, people and systems or from
    external events.
  • The definition does include legal risk but
    however does not include systemic risk,
    strategic/business risk and reputational risk.

14
3. Risk factors Measurement of Credit Risk
  • The basic measurement is empirical a loan is
    supposedly priced according to how much risk it
    involves.
  • The measurement of such risk implies assessing
    the borrowers creditworthiness.
  • Three main components enter into the measurement
    of credit risk size of exposure, default
    probability of borrower and loss probability once
    the borrower has defaulted.
  • When generalized to the whole bank, the
    institution relate its economic capital for
    credit risk to its portfolios probability
    density function of credit losses

15
Probability Density Function of Credit Losses
Economic capital
Frequency of loss
Stress loss
? Expected loss
Unexpected loss
0
Amount of loss
  • Large number of small losses
  • Few occasions with severe losses

16
3. Probability Density Function (PDF)
  • Expected credit loss
  • Amount of credit loss a bank expects to
    experience on its credit portfolio over the
    chosen time horizon
  • Ideally, provisions should cover expected losses
  • Unexpected credit losses
  • Amount by which actual losses exceed expected
    loss
  • (Economic) capital should cover unexpected losses
  • A risky portfolio is one whose PDF has a
    relatively long and fat tail

17
3. Definition of Loss
  • Credit loss arises only if a borrower defaults
  • Inputs
  • Default rates Obligors internal credit risk
    rating
  • Default horizon Typically 1 year
  • Exposure Exposure at default
  • Recovery rate 1-recovery rate Loss-given
    default
  • Correlations Correlation between credit losses

18
3. But what is a Default?
  • Different definitions possible
  • Firm is unlikely to pay its debt obligations
  • Credit loss event associated with any other
    obligation of the firm
  • Firm is past due more than 90 days (or more?)
  • Firm has filed for bankruptcy or similar
    protection

19
3. Probability of Default - Measurement
  • Within most internal rating systems, key
    criterion is internal credit risk rating
  • Bank establishes set of grades with specific
    probability of default
  • Banks assign risk rating to each customer by
    using
  • Financial and other characteristics of customer
  • Vendor-supplied commercial credit scoring model
  • Internally developed credit scoring model
  • Often banks relate internal rating to external
    rating standards
  • Bank places customer into predefined risk rating
    category

20
3. Slotting of Loans into PD Grades
Loan A Loan B Loan C Loan D PD 0.02 PD
0.15 PD 0.68 PD 15
21
3. Time horizon for monitoring credit risk
  • One-year horizon reflects the typical interval
    over which e.g.
  • New capital could be raised
  • Loss mitigation action could be taken
  • Internal budgeting, capital planning and
    accounting statements are prepared

22
3. Correlations between Credit Events
  • Not all obligors will default at once
  • But financial conditions of firms in the same
    industry or within the same country may reflect
    similar factors
  • Assessing such correlations is still quite
    limited
  • The importance of such a risk has been
    traditionally recognized in banking it is
    closely related to risk concentration and
    diversification of exposures
  • It has become more difficult to assess because
    of globalization/inter-actions concentrations
    can be to one borrower or related borrowers, one
    sector or related sectors, one country or
    geographical area.

23
4. Credit Risk management Guidance provided by
the Basel Committee
  • Core Principles for Effective Banking Supervision
    (1997)
  • Core Principles Methodology Paper (1999)
  • Principles for the Management of Credit Risk
    (2000)

24
4. Credit Risk Management
  • Banks need to manage the credit risk inherent in
    the entire portfolio as well as the risk in
    individual credits or transactions
  • Banks should also consider the relationship
    between credit risk and other risks
  • Sound credit risk management practices should be
    applied in conjunction with sound practices
    related to the assessment of asset quality, the
    adequacy of provisions and reserves, and the
    disclosure of credit risk

25
4. Credit Risk Management Process
  • Establishing an appropriate credit risk
    environment
  • Operating under a sound credit granting process
  • Maintaining an appropriate credit administration
    and monitoring process
  • Ensuring adequate controls over credit risk
  • Role of Supervisors in the process.
Write a Comment
User Comments (0)
About PowerShow.com