Credit Risk Management - GARP

1 SECTION 1 Credit Risk Assessment • The differences between credit and market risk • Credit policy and credit risk • Credit risk assessment framework • Inputs to credit models SECTION 2 The Risks of Credit Products • Retail credit • Small and Medium Enterprises • Corporate credit • Counterparty credit • Sovereign credit Credit Risk Management Table of Contents SECTION 3 Credit Risk Portfolio Management • The different types of default correlation • Methods of aggregating credit risk • Securitization as a risk management tool • Credit derivatives and their role in credit risk management • Managing non-performing assets • Reporting credit risk SECTION 4 The Regulatory View • Linking capital and credit risk • The evolution of the

Basel Accords • The Standardized Approach to compute credit risk capital requirements • The Internal Rating Based Approaches to compute credit risk capital requirements • Regulatory treatment of securitization activities 2 The four chapters of this book focus on credit risks. Chapter 1 focuses on credit risk and the governance of credit risk management, while Chapter 2 analyzes the risk of various credit products.Chapter 3 discusses credit risk assessment tools, debt pricing, and credit risk hedging, and the final Chapter 4 analyzes the regulatory view of credit risk capital requirements. This chapter assumes prior exposure to basic credit analysis and focuses on a credit risk assessment framework that is used to value credit-linked obligations, such as loans, bonds and lines of credit, as well as assessing the risk of those obligations. Building on this basis, the chapter addresses credit and its governance—including the credit policies and governance of credit within the bank—before moving to analyze the core risk concerns in the credit assessment process for both bonds and loans. This chapter addresses: • The differences between credit and market risk • Credit policy and credit risk • Credit risk assessment framework • Inputs to credit models It is important to recognize that the credit risk termin- ology used in this book relates to all classes of credit risk listed. 1.1 DISTINGUISHING CREDIT RISK FROM MARKET RISK For most bankers, credit risk is much more important than market risk. These are bankers who focus much more on traditional lending and credit, and less on capital market activity. Understanding credit risk requires some familiarity with market risk, a topic outlined and discussed in Market Risk Management, another volume in the GARP Risk Series. 1.1.1 Credit Risk Indeed, the basic concepts for measuring credit risk— probability of default, recovery rate, exposure at default, expected loss, loss given default, and unexpected loss— are easy enough to understand and explain. However, even for those involved in risk management who agree on the concepts, it is not always easy to practically implement a method that is fully consistent with an original concept. Minor differences in how credit risk is estimated and meas- ured can often result in large swings in estimates of credit risk, and how to proactively manage the credit risk. Such movements can have significant impacts on risk assess- ments and ultimately on business decisions (including the using of collateral, securitization and credit risk...

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