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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.

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Credit risk management l.jpg

CREDIT RISK MANAGEMENT

THE COMMODITISATION OF CREDIT RISK

TRENDS IN CREDIT RISK MANAGEMENT


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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


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AGENDA

  • KEY DRIVERS OF CHANGE

  • CREDIT RISK MANAGEMENT PARADIGMS

    • CLASSICAL

    • MODERN

  • CREDIT RISK MANAGEMENT ARCHITECTURE

  • IMPLICATIONS FOR FINANCIAL SERVICES


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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


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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


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PRODUCT/ KNOWLEDGE MANAGEMENT

CAPITAL MANAGEMENT

RISK MANAGEMENT

TECHNOLOGY MANAGEMENT

RISK

ORIGINATION/ DISTRIBUTION

PRODUCT MANUFACTURE

PROCESSING/ ADMINISTRATION

PRODUCT FOCUS

CLIENT FOCUS


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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


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KEY DRIVERS OF CHANGE

COSTS OF CREDIT RISK MANAGEMENT INFRASTRUCTURE

LIQUEFACTION OF CREDIT RISK

SYNDICATION & ASSET SALES

SECURITISATION

CREDIT DERIVATIVES & CREDIT LINKED NOTES


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DEVELOPMENTS IN CREDIT ENHANCEMENT TECHNIQUES

BI-LATERAL

MULTILATERAL

ADVANCES IN CREDIT/ DEFAULT RISK THEORY

INFRASTRUCTURE DEVELOPMENTS

SYSTEMS CAPABILITIES

KEY DRIVERS OF CHANGE


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KEY DRIVERS OF CHANGE

CHANGE IN REGULATORY FRAMEWORK

SHIFT TO CAPITAL BASED REGULATION

REGULATORY ARBITRAGE

(POSSIBILITY) OF MODEL BASED CREDIT RISK CAPITAL


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KEY DRIVERS OF CHANGE

KEY NEAR TERM FACTORS

CREDIT CAPITAL MANAGEMENT

CREDIT PRICING

CREDIT RISK MANAGEMENT

REGULATORY DEVELOPMENTS

SHIFTS IN BANKING STRATEGY


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CREDIT RISK PARADIGMS

TYPES

CLASSICAL

MODERN

KEY ISSUE

APPLICABILITY TO DIFFERENT MARKET SEGMENTS


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CREDIT RISK BY MARKET SEGMENT

SEGMENTS

RETAIL

MID-MARKET

WHOLESALE/ CORPORATES

DIMENSIONS

RISK

PRICING

CREDIT METHODOLOGY

LIQUIDITY AND TRADEABILITY


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LARGE

RETAIL

MID-MARKET

NUMBER OF COUNTERPARTIES

WHOLESALE

SMALL

HIGH

LOW

SIZE OF INDIVIDUAL EXPOSURE


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CLASSICAL PARADIGM

CONCEPT

ASSESS RISK AND MATCH WITH CAPITAL

RISK MANAGEMENT TECHNIQUES

DIVERSIFICATION

COLLATERAL

SCHEMATIC


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  • 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


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CLASSICAL PARADIGM

KEY ELEMENTS

CREDIT ANALYSIS AND ASSESSMENT PROCESS


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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


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MODERN PARADIGM

CONCEPT

CREDIT RISK AS A SEPARATE TRADEABLE ASSET CLASS

RISK MANAGED DYNAMICALLY THROUGH HEDGING AND TRADING TOOLS

SCHEMATIC


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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


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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


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MODERN PARADIGM

KEY ELEMENTS

CREDIT ANALYSIS AND ASSESSMENT PROCESS


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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


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IMPLICATIONS OF MODERN PARADIGM

CLIENT MANAGEMENT

CORE VERSUS NON CORE CLIENTS

HOME VERSUS FOREIGN MARKETS


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CREDIT RISK MANAGEMENT ARCHITECTURE

CONCEPT

RISK MANAGEMENT SYSTEMS COMPONENTS

INFORMATION SYSTEMS

SCHEMATICS


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  • 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


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IMPLICATIONS FOR FINANCIAL SERVICES

  • TYPES

    • MICRO(OPERATIONAL)

      • REDEFINITION OF CREDIT PROCESS WITHIN ORGANISATIONS

    • MACRO(STRATEGIC)

      • REDEFINITION OF BUSINESS FOCUS


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OPERATIONAL CHANGES

  • RE-ENGINEERING THE CREDIT PROCESS

  • ALTERATION OF CREDIT RISK ARCHITECTURE/ INFRASTRUCTURE


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STRATEGIC CHANGES

  • THEME

    • SHIFT FOCUS OF BANKS FROM HOLDER OF RISK TO ORIGINATORS AND DISTRIBUTORS OF RISK

  • MODELS OF BANKING PRACTICE


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MODEL 1 - CLASSICAL BANKING MODEL

LOAN TRANSACTION

DEPOSIT TRANSACTION

DEPOSITOR

BORROWER

BANK

BANK ORIGINATES, FUNDS, ADMINISTERS AND RETAINS CREDIT RISK OF BORROWER


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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,


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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


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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.


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KEY CHALLENGES

  • CREDIT RISK MODELLING PROBLEMS

  • DEVELOPMENT OF CREDIT TRADING

  • CREDIT ENHANCEMENT PROBLEMS

  • CHANGES IN CREDIT INFRASTRUCTURE

  • CHANGE MANAGEMENT


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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